Beginners Guide to Commodities Futures Trading in India Indian markets have recently thrown open a new avenue for

retail investors and traders to participate: commodity derivatives. For those who want to diversify their portfolios beyond shares, bonds and real estate, commodities is the best option. Till some months ago, this wouldn't have made sense. For retail investors could have done very little to actually invest in commodities such as gold and silver -- or oilseeds in the futures market. This was nearly impossible in commodities except for gold and silver as there was practically no retail avenue for punting in commodities. However, with the setting up of three multi-commodity exchanges in the country, retail investors can now trade in commodity futures without having physical stocks! Commodities actually offer immense potential to become a separate asset class for market-savvy investors, arbitrageurs and speculators. Retail investors, who claim to understand the equity markets may find commodities an unfathomable market. But commodities are easy to understand as far as fundamentals of demand and supply are concerned. Retail investors should understand the risks and advantages of trading in commodities futures before taking a leap. Historically, pricing in commodities futures has been less volatile compared with equity and bonds, thus providing an efficient portfolio diversification option. In fact, the size of the commodities markets in India is also quite significant. Of the country's GDP of Rs 13,20,730 crore (Rs 13,207.3 billion), commodities related (and dependent) industries constitute about 58 per cent. Currently, the various commodities across the country clock an annual turnover of Rs 1,40,000 crore (Rs 1,400 billion). With the introduction of futures trading, the size of the commodities market grow many folds here on. Like any other market, the one for commodity futures plays a valuable role in information pooling and risk sharing. The market mediates between buyers and sellers of commodities, and facilitates decisions related to storage and consumption of commodities. In the process, they make the underlying market more liquid.

Here's how a retail investor can get started:

Where do I need to go to trade in commodity futures? You have three options - the National Commodity and Derivative Exchange, the Multi Commodity Exchange of India Ltd and the National Multi Commodity Exchange of India Ltd. All three have electronic trading and settlement systems and a national presence. How do I choose my broker? Several already-established equity brokers have sought membership with NCDEX and MCX. The likes of Refco Sify Securities, SSKI (Sharekhan) and ICICIcommtrade (ICICIdirect), ISJ Comdesk (ISJ Securities) and Sunidhi Consultancy are already offering commodity futures services. Some of them also offer trading through Internet just like the way they offer equities. You can also get a list of more members from the respective exchanges and decide upon the broker you want to choose from. What is the minimum investment needed? You can have an amount as low as Rs 5,000. All you need is money for margins payable upfront to exchanges through brokers. The margins range from 5-10 per cent of the value of the commodity contract. While you can

start off trading at Rs 5,000 with ISJ Commtrade other brokers have different packages for clients. For trading in bullion, that is, gold and silver, the minimum amount required is Rs 650 and Rs 950 for on the current price of approximately Rs 65,00 for gold for one trading unit (10 gm) and about Rs 9,500 for silver (one kg). The prices and trading lots in agricultural commodities vary from exchange to exchange (in kg, quintals or tonnes), but again the minimum funds required to begin will be approximately Rs 5,000. Do I have to give delivery or settle in cash? You can do both. All the exchanges have both systems - cash and delivery mechanisms. The choice is yours. If you want your contract to be cash settled, you have to indicate at the time of placing the order that you don't intend to deliver the item. If you plan to take or make delivery, you need to have the required warehouse receipts. The option to settle in cash or through delivery can be changed as many times as one wants till the last day of the expiry of the contract. What do I need to start trading in commodity futures? As of now you will need only one bank account. You will need a separate commodity demat account from the National Securities Depository Ltd to trade on the NCDEX just like in stocks. What are the other requirements at broker level? You will have to enter into a normal account agreements with the broker. These include the procedure of the Know Your Client format that exist in equity trading and terms of conditions of the exchanges and broker. Besides you will need to give you details such as PAN no., bank account no, etc. What are the brokerage and transaction charges? The brokerage charges range from 0.10-0.25 per cent of the contract value. Transaction charges range between Rs 6 and Rs 10 per lakh/per contract. The brokerage will be different for different commodities. It will also differ based on trading transactions and delivery transactions. In case of a contract resulting in delivery, the brokerage can be 0.25 - 1 per cent of the contract value. The brokerage cannot exceed the maximum limit specified by the exchanges. Where do I look for information on commodities? Daily financial newspapers carry spot prices and relevant news and articles on most commodities. Besides, there are specialised magazines on agricultural commodities and metals available for subscription. Brokers also provide research and analysis support. But the information easiest to access is from websites. Though many websites are subscription-based, a few also offer information for free. You can surf the web and narrow down you search. Who is the regulator? The exchanges are regulated by the Forward Markets Commission. Unlike the equity markets, brokers don't need

to register themselves with the regulator. The FMC deals with exchange administration and will seek to inspect the books of brokers only if foul practices are suspected or if the exchanges themselves fail to take action. In a sense, therefore, the commodity exchanges are more self-regulating than stock exchanges. But this could change if retail participation in commodities grows substantially. Who are the players in commodity derivatives? The commodities market will have three broad categories of market participants apart from brokers and the exchange administration - hedgers, speculators and arbitrageurs. Brokers will intermediate, facilitating hedgers and speculators. Hedgers are essentially players with an underlying risk in a commodity - they may be either producers or consumers who want to transfer the price-risk onto the market. Producer-hedgers are those who want to mitigate the risk of prices declining by the time they actually produce their commodity for sale in the market; consumer hedgers would want to do the opposite. For example, if you are a jewellery company with export orders at fixed prices, you might want to buy gold futures to lock into current prices. Investors and traders wanting to benefit or profit from price variations are essentially speculators. They serve as counterparties to hedgers and accept the risk offered by the hedgers in a bid to gain from favourable price changes. In which commodities can I trade? Though the government has essentially made almost all commodities eligible for futures trading, the nationwide exchanges have earmarked only a select few for starters. While the NMCE has most major agricultural commodities and metals under its fold, the NCDEX, has a large number of agriculture, metal and energycommodities. MCX also offers many commodities for futures trading. Do I have to pay sales tax on all trades? Is registration mandatory? No. If the trade is squared off no sales tax is applicable. The sales tax is applicable only in case of trade resulting into delivery. Normally it is the seller's responsibility to collect and pay sales tax. The sales tax is applicable at the place of delivery. Those who are willing to opt for physical delivery need to have sales tax registration number. What happens if there is any default? Both the exchanges, NCDEX and MCX, maintain settlement guarantee funds. The exchanges have a penalty clause in case of any default by any member. There is also a separate arbitration panel of exchanges. Are any additional margin/brokerage/charges imposed in case I want to take delivery of goods? Yes. In case of delivery, the margin during the delivery period increases to 20-25 per cent of the contract value. The member/ broker will levy extra charges in case of trades resulting in delivery.

Is stamp duty levied in commodity contracts? What are the stamp duty rates? As of now, there is no stamp duty applicable for commodity futures that have contract notes generated in electronic form. However, in case of delivery, the stamp duty will be applicable according to the prescribed laws of the state the investor trades in. This is applicable in similar fashion as in stock market. How much margin is applicable in the commodities market? As in stocks, in commodities also the margin is calculated by (value at risk) VaR system. Normally it is between 5 per cent and 10 per cent of the contract value. The margin is different for each commodity. Just like in equities, in commodities also there is a system of initial margin and mark-to-market margin. The margin keeps changing depending on the change in price and volatility. Are there circuit filters? Yes the exchanges have circuit filters in place. The filters vary from commodity to commodity but the maximum individual commodity circuit filter is 6 per cent. The price of any commodity that fluctuates either way beyond its limit will immediately call for circuit breaker. Interested in commodities futures trading? Beginners Guide to Commodities Futures Trading in India

1. Commodity and Commodities market

1.1 INTRODUCTION

India, a commodity based economy where two-third of the one billion population depends on agricultural commodities, surprisingly has an under developed commodity market. Unlike the physical market, futures markets trades in commodity are largely used as risk management (hedging) mechanism on either physical commodity itself or open positions in commodity stock.

For instance, a jeweler can hedge his inventory against perceived short-term downturn in gold prices by going short in the future markets.

The article aims at know how of the commodities market and how the commodities traded on the exchange. The idea is to understand the importance of commodity derivatives and learn about the market from Indian point of view. In fact it was one of the most vibrant markets till early 70s. Its development and growth was shunted due to numerous restrictions earlier. Now, with most of these restrictions being removed, there is tremendous potential for growth of this market in the country.

1.2 COMMODITY

A commodity may be defined as an article, a product or material that is bought and sold. It can be classified as every kind of movable property, except Actionable Claims, Money & Securities.

Commodities actually offer immense potential to become a separate asset class for market-savvy investors, arbitrageurs and speculators. Retail investors, who claim to understand the equity markets, may find commodities an unfathomable market. But commodities are easy to understand as far as fundamentals of demand and supply are concerned. Retail investors should understand the risks and advantages of trading in commodities futures before taking a leap. Historically, pricing in commodities futures has been less volatile compared with equity and bonds, thus providing an efficient portfolio diversification option.

In fact, the size of the commodities markets in India is also quite significant. Of the country's GDP of Rs 13, 20,730 crore (Rs 13,207.3 billion), commodities related (and dependent) industries constitute about 58 per cent.

Currently, the various commodities across the country clock an annual turnover of Rs 1, 40,000 crore (Rs 1,400 billion). With the introduction of futures trading, the size of the commodities market grows many folds here on.

1.3 COMMODITY MARKET

Commodity market is an important constituent of the financial markets of any country. It is the market where a wide range of products, viz., precious metals, base metals, crude oil, energy and soft commodities like palm oil, coffee etc. are traded. It is important to develop a vibrant, active and liquid commodity market. This would help investors hedge their commodity risk, take speculative positions in commodities and exploit arbitrage opportunities in the market.

Table: 1

Turnover in Financial Markets and Commodity Market

(Rs in Crores)

S No.

Market segments

2002-03

2003-04

2004-05 (E)

Government Securities Market

1,544,376

(63)

2,518,322

(91.2)

2,827,872

(91)

Forex Market

658,035

(27)

2,318,531

(84)

3,867,936

(124.4)

Total Stock Market Turnover (I+ II)

1,374,405

(56)

3,745,507

(136)

4,160,702

(133.8)

National Stock Exchange (a+b)

1,057,854

(43)

3,230,002

(117)

3,641,672

(117.1)

a)Cash

617,989

1,099,534

1,147,027

b)Derivatives

439,865

2,130,468

2,494,645

II

Bombay Stock Exchange (a+b)

316,551

(13)

515,505

(18.7)

519,030

(16.7)

a)Cash

314,073

503,053

499,503

b)Derivatives

2,478

12,452

19,527

Commodities Market

NA

130,215

(4.7)

500,000

(16.1)

Note: Fig. in bracket represents percentage to GDP at market prices

Source: Sebi bulletin

1.4 Its EVOLUTION IN INDIA Bombay Cotton Trade Association Ltd., set up in 1875, was the first organized futures market. Bombay Cotton Exchange Ltd. was established in 1893 following the widespread discontent amongst leading cotton mill owners and merchants over functioning of Bombay Cotton Trade Association. The Futures trading in oilseeds started in 1900 with the establishment of the Gujarati Vyapari Mandali, which carried on futures trading in groundnut, castor seed and cotton. Futures' trading in wheat was existent at several places in Punjab and Uttar Pradesh. But the most notable futures exchange for wheat was chamber of commerce at Hapur set up in 1913. Futures trading in bullion began in Mumbai in 1920. Calcutta Hessian Exchange Ltd. was established in 1919 for futures trading in raw jute and jute goods. But organized futures trading in raw jute began only in 1927 with the establishment of East Indian Jute

Association Ltd. These two associations amalgamated in 1945 to form the East India Jute & Hessian Ltd. to conduct organized trading in both Raw Jute and Jute goods. Forward Contracts (Regulation) Act was enacted in 1952 and the Forwards Markets Commission (FMC) was established in 1953 under the Ministry of Consumer Affairs and Public Distribution. In due course, several other exchanges were created in the country to trade in diverse commodities.

1.5 Structure of Commodity Market

1.6 Different types of commodities traded World-over one will find that a market exits for almost all the commodities known to us. These commodities can be broadly classified into the following:

Precious Metals: Gold, Silver, Platinum etc Other Metals: Nickel, Aluminum, Copper etc Agro-Based Commodities: Wheat, Corn, Cotton, Oils, Oilseeds. Soft Commodities: Coffee, Cocoa, Sugar etc Live-Stock: Live Cattle, Pork Bellies etc Energy: Crude Oil, Natural Gas, Gasoline etc

1.7 Different segments in Commodities market

The commodities market exits in two distinct forms namely the Over the Counter (OTC) market and the Exchange based market. Also, as in equities, there exists the spot and the derivatives segment. The spot markets are essentially over the counter markets and the participation is restricted to people who are involved with that commodity say the farmer, processor, wholesaler etc. Derivative trading takes place through exchange-based markets with standardized contracts, settlements etc.

1.8 Leading commodity markets of world

Some of the leading exchanges of the world are New York Mercantile Exchange (NYMEX), the London Metal Exchange (LME) and the Chicago Board of Trade (CBOT).

1.9 Leading commodity markets of India

The government has now allowed national commodity exchanges, similar to the BSE & NSE, to come up and let them deal in commodity derivatives in an electronic trading environment. These exchanges are expected to offer a nation-wide anonymous, order driven, screen based trading system for trading. The Forward Markets Commission (FMC) will regulate these exchanges.

Consequently four commodity exchanges have been approved to commence business in this regard. They are:

Multi Commodity Exchange (MCX) located at Mumbai. National Commodity and Derivatives Exchange Ltd (NCDEX) located at Mumbai. National Board of Trade (NBOT) located at Indore. National Multi Commodity Exchange (NMCE) located at Ahmedabad.

Turnover on Commodity Futures Markets

(Rs. In Crores)

Exchange

2003-04

2004-05 FIRST Half

NCDEX

1490

54011

NBOT

53014

51038

MCX

2456

30695

NMCE

23842

7943

ALL EXCHANGES

129364

170720

1.10 Volumes in Commodity Derivatives Worldwide

2. Commodity Futures Trading in India 2.1 INTRODUCTION

Derivatives as a tool for managing risk first originated in the Commodities markets. They were then found useful as a hedging tool in financial markets as well. The basic concept of a derivative contract remains the same whether the underlying happens to be a commodity or a financial asset. However there are some features, which are very peculiar to commodity derivative markets. In the case of financial derivatives, most of these contracts are cash settled. Even in the case of physical settlement, financial assets are not bulky and do not need special facility for storage. Due to the bulky nature of the underlying assets, physical settlement in commodity derivatives creates the need for warehousing. Similarly, the concept of varying quality of asset does not really exist as far as financial underlyings are

concerned. However in the case of commodities, the quality of the asset underlying a contract can vary largely. This becomes an important issue to be managed.

2.2 Benefits to Industry from Futures trading.

* Hedging the price risk associated with futures contractual commitments. * Spaced out purchases possible rather than large cash purchases and its storage. * Efficient price discovery prevents seasonal price volatility. * Greater flexibility, certainty and transparency in procuring commodities would aid bank lending. * Facilitate informed lending. * Hedged positions of producers and processors would reduce the risk of default faced by banks. * Lending for agricultural sector would go up with greater transparency in pricing and storage. * Commodity Exchanges to act as distribution network to retail agri-finance from Banks to rural households. * Provide trading limit finance to Traders in commodities Exchanges.

2.3 Benefits to Exchange Member

* Access to a huge potential market much greater than the securities and cash market in commodities. * Robust, scalable, state-of-art technology deployment. * Member can trade in multiple commodities from a single point, on real time basis. * Traders would be trained to be Rural Advisors and Commodity Specialists and through them multiple rural needs would be met, like bank credit, information dissemination, etc.

2.4 Why Commodity Futures?

One answer that is heard in the financial sector is "we need commodity futures markets so that we will have volumes, brokerage fees, and something to trade''. I think that is missing the point. We have to look at futures market in a bigger perspective -- what is the role for commodity futures in India's economy?

In India agriculture has traditionally been an area with heavy government intervention. Government intervenes by trying to maintain buffer stocks, they try to fix prices, and they have import-export restrictions and a host of other interventions. Many economists think that we could have major benefits from liberalization of the agricultural sector.

In this case, the question arises about who will maintain the buffer stock, how will we smoothen the price fluctuations, how will farmers not be vulnerable that tomorrow the price will crash when the crop comes out, how will farmers get signals that in the future there will be a great need for wheat or rice. In all these aspects the futures market has a very big role to play.

If you think there will be a shortage of wheat tomorrow, the futures prices will go up today, and it will carry signals back to the farmer making sowing decisions today. In this fashion, a system of futures markets will improve cropping patterns.

Next, if I am growing wheat and am worried that by the time the harvest comes out prices will go down, then I can sell my wheat on the futures market. I can sell my wheat at a price, which is fixed today, which eliminates my risk from price fluctuations. These days, agriculture requires investments -- farmers spend money on fertilizers, high yielding varieties, etc. They are worried when making these investments that by the time the crop comes out prices might have dropped, resulting in losses. Thus a farmer would like to lock in his future price and not be exposed to fluctuations in prices.

The third is the role about storage. Today we have the Food Corporation of India, which is doing a huge job of storage, and it is a system, which -- in my opinion -- does not work. Futures market will produce their own kind of smoothing between the present and the future. If the future price is high and the present price is low, an arbitrager will buy today and sell in the future. The converse is also true, thus if the future price is low the arbitrageur will buy in the futures market. These activities produce their own "optimal" buffer stocks, smooth prices. They also work very effectively when there is trade in agricultural commodities; arbitrageurs on the futures market will use imports and exports to smooth Indian prices using foreign spot markets.

In totality , commodity futures markets are a part and parcel of a program for agricultural liberalization. Many agriculture economists understand the need of liberalization in the sector. Futures markets are an instrument for achieving that liberalization. http://www.indianmba.com/Occasional_Papers/OP62/op62.html

A commodity is an article of commerce or trade that is in demand and sold by various suppliers without any qualitative differentiation. It is a product that is the same no matter who produces it, such as petroleum, notebook paper, or milk. The commodity market is a geographical location where the seller and buyer meet to transfer the ownership of goods from the former to the latter through negotiation at mutually agreed value. For a commodity market to be functioning, the important ingredients are commodity, buyer and seller. The market place may be organized or unorganized depending upon the aggregation of the buyer and seller at certain geographical location and at a certain given time. With the development of various means of communication, development of storage system, better means of transportation and the advanced form of payment has broadened the definition of the commodity market. Commodity is divided in various categories based on the source of production like agri and non agri. Non agri commodity is again divided among metals and energy. Metals are divided into precious such as steel, copper etc. Based on the storability factor, like perishable items include vegetables, fruits and milk and non perishable items include metals or semi perishable like cereals and pulses. World-over, one will find that a market exits for almost all the commodities known to us. These commodities can be broadly classified into the following: The commodity markets have their origins in the ancient civilization of Sumer in southern Iraq. Tokens were used to trade commodities. This included specific timeframes and the delivery of commodities, just like contemporary futures contracts. By the 19 century, the crude commodity markets paved the way for modern, regulated and standardized markets in the US, where agricultural products and cattle were traded. The modern commodity markets have their roots in the traded. The modern commodity markets have their roots in the trading of agricultural products. The commodities market exits in two distinct forms namely the over the counter (OTC) market and the exchange based market. The OTC markets are essentially spot markets and are localized for specific commodities. Almost all the trading that takes place in these markets is delivery based. The spot markets are essentially over the counter markets and the participation is restricted to people who are involved with that commodity say the farmer, processor, wholesaler etc. In addition to the spot transactions, forward deals also take place in these markets. However, they too happen on a delivery basis and hence are restricted to the participants in the spot markets. Majority of the

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http://hubpages.com/hub/Introduction-to-commodity-market

An Introduction to Commodity Markets

Commodities are raw or primary products and the exchanges where these goods are traded are known as Commodity Markets. Different markets trade different commodities. For example, the Winnipeg Commodity Exchange is Canadas only agricultural futures and options exchange. Here, you will find investors trading in canola, wheat, barley and other agricultural products. Other commodities can be found in either the Toronto Stock Exchange, the Canadian Venture Exchange or the Montreal Exchange, depending on the type of commodity and the size of the company managing it. Internationally, commodities are available on almost every exchange.

When investing in any commodity, it is important to understand the unit that it is being traded in. For example, one unit of gold is one troy ounce; therefore, the price per unit is the price per ounce. Nickel, while still a metal, is bought and sold by the metric ton, as are most other industrial metals. Fuels such as crude oil, diesel and gasoline may be traded by the barrel or by the metric ton. Food items such as maize, wheat and soybeans may be sold by the pound, bushel, short ton, kilogram, short hundredweight, or even a set multiple of any of these units. Without understanding the unit price, an investor cannot comprehend the price they are actually paying for any given commodity.

Oil is the most traded commodity in the world, with coffee coming in second place. Because many commodities are mined or produced in various countries, more and more companies are seeking the Fair Trade designation. This allows an investor to choose to invest in commodities that are produced using fair wages for laborers, regulated working conditions, etc. Investors with a social conscience may use this designation as one of their criteria when investing in foreign commodities.

In Canada, commodity measurements are regulated and inspected by Measurement Canada, working within The Weights and Measures Act. This helps to ensure that investors can trust that the commodity they choose to invest in has been accurately weighed and measured. While commodities in Canada are produced for both domestic and foreign markets, some are regulated within this country to ensure a balance between supply and demand. This regulation of commodities such as poultry, eggs and dairy helps to ensure a safe return for investors.

Considering that more than half of Canadas export trade is in commodities, market price fluctuations can easily affect the performance of the exchange as a whole.

http://www.stocktrades.ca/investment-basics/an-introduction-to-commodity-markets/