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There are mainly two types of futures trading contracts available in a futures market as those require a physical delivery and those require a cash settlement
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Two Major Commodities Exchange in India • MCX (Multi Commodity Exchange) • NCDEX (National Commodities & Derivatives Exchange)
Commodities traded on the exchanges Agri Products: Precious Metals: • Jeera • Gold • Pepper • Silver • Chilli • Platinum • Turmeric • Guar Seed • Guar Gum • Soya bean • Sugar • Maize
Commodities traded on the exchanges Base Metals: Energy: • Copper • Crude oil • Nickel • Natural Gas • Lead • Zinc • Aluminum • Tin
Other Information • Exchange Timings • Agri Products: 10:00 AM To 5:00 PM • Other Commodities: 10:00 AM To 11:30 PM • Instrument Traded: Futures Contract • Expiry of Contracts : Different for different commodities
What are Commodity futures? • A Financial Contract • The underlying commodity is bought or sold at a future date • A tool used by Investors, Hedgers, Arbitrageurs, Day Traders
Why futures trading in Commodities? • Portfolio diversification and risk management • Additional investment opportunity • Low cost business • No Transportation, storage, insurance, security charges • Low Margins – High leverage • Intrinsic value of the commodity • Domain knowledge of industry • Hedging/ Arbitrage
Purpose of Futures Markets • Meet the needs of three groups of future market users • Those who wish to discover information about future prices of commodities (suppliers) • Those who wish to speculate (speculators) • Those who wish to transfer risk to some other party (hedgers) • Those who want to take advantage of price difference in different markets (Arbitrageurs)
Commodity Futures Market – Participants • Hedgers • Producers – Farmers • Consumers – Refineries, Food processing companies • Speculators • Institutional proprietary traders • Brokerage houses • Spot Commodity traders • Arbitrageurs • Brokerage houses • Investors
Risks encountered by industry • Price volatility depends on International market movement • Results in higher procurement cost reducing operational margins • No options or tools were available earlier • Directionless market • No control measures • Counter party Risk • Credit risk especially during periods of volatile prices • Quantity risk during shortages • Quality Risk
Benefits… • Investor: • Portfolio diversification and risk management • Additional investment opportunity • Physical trader: • Low cost business • No Transportation, storage, insurance, security Charges • Domain knowledge of industry • Traders: • Low Margins – High leverage • No balance-Sheet, P&L, EBITDA • Hedging/ Arbitrage
Hedging • Purpose • Avoid risk of adverse market movements • Rationale • Cash and Futures prices tend to move in tandem • Converge at close to expiry • Types of Hedges • Long Hedge, Short Hedge • Advantages • Lock in a price and margin in advance • Disadvantages • Limits opportunities if prices move favorably
Types of Hedging • Long Hedge • Hedges that involve taking a long position in futures contract • Appropriate when a company plans to owns certain asset in the future • Short Hedge • Hedges that involve taking a short position in futures contract • Appropriate when the hedger already owns the asset or likely to own the asset and expects to sell it in future
Short Hedge - Example • Suppose:- • COPPER producer wants to sell COPPER in future. • There is an equal chances of price going up or down. • There is a risk if price goes down.
Long Hedge- Example • Scenario of consumer who wishes to lock input prices • There is an equal chances of price going up or down. • There is a risk if price goes up.
