Commodity trading


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Commodity trading

  2. 2. INTRODUCTIONCommodity trading in India is regulated by the Forward Markets Commission(FMC) headquartered at Mumbai, it is a regulatory authority which is overseen bythe Ministry of Consumer Affairs and Public Distribution, Govt. of India. It is astatutory body set up in 1953 under the Forward Contracts (Regulation) Act, 1952.COMMODITY TRADINGCommodity markets are quite like equity markets. The commodity market also has twoconstituents i.e. spot market and derivative market. In case of a spot market, the commoditiesare bought and sold for immediate delivery. In case of a commodities derivative market, variousfinancial instruments having commodities as underlying are traded on the exchanges. It hasbeen seen that traditionally in India people have hedged their risks with Gold and Silver.COMMODITY FUTURESCommodity future is a derivative instrument for the future delivery of a commodity on a fixeddate at a particular price. The underlying in this case is a particular commodity.If an investor purchases an oil future, he is entering into a contract to buy a fixed quantity of oilat a future date. The future date is called the contract expiry date. The fixed quantity is calledthe contract size. These futures can be bought and sold on the commodity exchanges.COMMODITIES TRADINGSpot tradingSpot trading is any transaction where delivery either takes place immediately, or with a minimum lagbetween the trade and delivery due to technical constraints. Spot trading normally involves visualinspection of the commodity or a sample of the commodity, and is carried out in markets suchas wholesale markets. Commodity markets, on the other hand, require the existence of agreed standardsso that trades can be made without visual inspection.Forward contractsA forward contract is an agreement between two parties to exchange at some fixed future date a givenquantity of a commodity for a price defined today. The fixed price today is known as the forward price.Early on these forward contracts were used as a way of getting products from producer to the consumer.These typically were only for food and agricultural products.Futures contractsA futures contract has the same general features as a forward contract but is standardized andtransacted through a futures exchange. Although more complex today, early forward contracts forexample, were used for rice in seventeenth century Japan.In essence, a futures contract is a standardized forward contract in which the buyer and the seller accept [2]the terms in regards to product, grade, quantity and location and are only free to negotiate the price.
  3. 3. HedgingHedging, a common practice of farming cooperatives, insures against a poor harvest bypurchasing futures contracts in the same commodity. If the cooperative has significantly less of its productto sell due to weather or insects, it makes up for that loss with a profit on the markets, since the overallsupply of the crop is short everywhere that suffered the same conditions.Delivery and condition guaranteesIn addition, delivery day, method of settlement and delivery point must all be specified. Typically, tradingmust end two (or more) business days prior to the delivery day, so that the routing of the shipment can befinalized via ship or rail, and payment can be settled when the contract arrives at any delivery point.TYPES OF COMMODITY EXCHANGES IN INDIA National Commodity & Derivatives Exchange Limited (NCDEX) Multi Commodity Exchange of India Limited (MCX) National Multi-Commodity Exchange of India Limited (NMCEIL) All the exchanges have been set up under overall control of Forward Market Commission (FMC) of Government of India. NATIONAL COMMODITY & DERIVATIVES EXCHANGE LIMITED (NCDEX) National Commodity & Derivatives Exchange Limited (NCDEX) located in Mumbai is a public limited company incorporated on April 23, 2003 under the Companies Act, 1956 and had commenced its operations on December 15, 2003.  This is the only commodity exchange in the country promoted by national level institutions.  NCDEX is regulated by Forward Market Commission and is subjected to various laws of the land like the Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and various other legislations. MULTI COMMODITY EXCHANGE OF INDIA LIMITED (MCX)  Headquartered in Mumbai Multi Commodity Exchange of India Limited (MCX), is an independent and de- mutulised exchang with a permanent recognition from Government of India.  Key shareholders of MCX are Financial Technologies (India) Ltd., State Bank of India, Union Bank of India, Corporation Bank, Bank of India and Canara Bank. MCX facilitates online trading, clearing and settlement operations for commodity futures markets across the country. NATIONAL MULTI-COMMODITY EXCHANGE OF INDIA LIMITED (NMCEIL)  National Multi Commodity Exchange of India Limited (NMCEIL) is the first de-mutualized, Electronic Multi-Commodity Exchange in India. On 25th July, 2001, it was granted approval by the Government to organise trading in the edible oil complex.  It has operationalised from November 26, 2002. It is being supported by Central Warehousing Corporation Ltd., Gujarat State Agricultural Marketing Board and Neptune Overseas Limited. It got its recognition in October 2002.
  4. 4. STEPS FOR TRADING IN COMMODITY FUTURES  Step One: Choosing a Broker  Step Two: Depositing the Margin  Step Three: Access to Information and a Trading Plan  Process Flow In Commodity Futures Trading.STEP ONE: CHOOSING A BROKERThe broker you choose should be a member of the exchanges you wish to trade in. Other than this, one should keepthe following factors in mind while choosing a broker:  Competitive edge provided by the broker.  Brokers knowledge of commodity markets.  Credibility of the broker.  Experience of the broker.  Net-worth of the broker.  Quality of brokers trading platforms.STEP TWO: DEPOSITING MARGIN IN COMMODITY TRADINGTo begin trading, the investor needs to deposit a margin with his broker. Margin requirements are of two types, theinitial margin and the maintenance margin. These margin requirements vary across commodities and exchanges buttypically, the initial margin ranges from 5-10% of the contract value.The maintenance margin is usually lower than the initial margin. The investors position is marked to market daily andany profit or loss is adjusted to his margin account. The investor has the option to withdraw any extra funds from hismargin account if his position generates a gain. Also, if the account falls below the maintenance margin, a margin callis generated from the broker and the investor needs to replenish his account to the initial level.STEP THREE: ACCES TO INFORMATION AND TRADING PLANAs commodity futures are not long-term investments, their performance needs to be monitored. The investor shouldhave access to the prevailing prices on the exchanges as well as market information that can help predict pricemovements. Brokers provide research and analysis to their clients. Other information sources are financial dailies,specialized magazines on commodities and the internet. Further, an investor requires a trading plan. Such a tradingplan can be developed in consultation with the broker. In any case, the investor has to remember to ride his profitsand cut his losses by using stop loss orders.PROCESS FLOWS IN COMMODITY FUTURES TRADINGAfter the process of opening account is done the investor may want to trade in commodity. IT is important tounderstand the process after the trade is placed.An investor places a trade order with the broker (at the dealing desk) on phone. The dealer puts the order inexchange trading system. At the initiation of the trade, a price is set and initial margin money is deposited in theaccount. At the end of the day, a settlement price is determined by the clearing house (Exchange). Depending on if
  5. 5. the markets have moved in favor or against the investors position the funds are either being drawn from or added tothe clients account. The amount is the difference in the traded price and the settlement price. On next day, thesettlement price is used as the base price. As the spot market prices changes every day, a new settlement price isdetermined at the end of every day. Again, the account will be adjusted by the difference in the new settlement priceand the previous nights price in the appropriate manner.Why commodities trading?Well, lets suppose you want to buy gold because you believe that the price of gold will rise.You could then buy gold ingots, store them, wait for them to go up in price, and then sell them at a profit.But, you have to be sure that the gold you buy is pure, you have to find a place to store it, you have to provide thesecurity, transport it to vault and other such hassles.A far better way to invest in gold would be to buy gold futures from the commodities exchange.How do you do that?When you buy a Gold Futures contract, you undertake to do three things.1. Buy the amount of gold specified in the contract.2. Buy it at the price specified in the contract.3. Buy it on the expiry of the contract. This could be after one month, two months, three months and so on. Of course,if you sell the Gold Futures contract before it expires, then you dont have to worry about actually buying the gold.How it worksWhen you buy a Futures, you dont have to pay the entire amount, just a fixed percentage of the cost. This is knownas the margin.Lets say you are buying a Gold Futures contract. The minimum contract size for a gold future is 100 gms. 100 gms ofgold may be worth Rs 72,000.The margin for gold set by MCX is 3.5%. So you only end up paying Rs 2,520.The low margin means that you can buy futures representing a large amount of gold by paying only a fraction of theprice.So you bought the Gold Futures contract when it was Rs 72,000 per 100 gms.The next day, the price of gold rose to Rs 73,000 per 100 gms.Rs 1,000 (Rs 73,000 – Rs 72,000) will be credited to your account.The following day, the price dips to Rs 72,500.Rs 500 will get debited from your account (Rs 73,000 - Rs 72,500).
  6. 6. What you need to knowCompared to stocks, trading in commodities is much cheaper, because margins are much lower than in stockfutures.Brokerage is low for commodity futures. It ranges from 0.05% to 0.12%.BENEFITS OF COMMODITIES FUTURESTo producer: A producer of a commodity can sell the futures of the commodity, thereby ensuring thathe can sell a particular quantity of his commodity at a particular price at a particular date.To investors: An investor has alternative investment instruments where he can take a position as tofuture price and the spot price at a particular date in future and buys and sells options. He is notinterested in taking deliveries of the commodities.To commodity trader: A commodity trader can use these to ensure that he is protected against anyadverse changes in the prices. He can enter into a futures contract for purchase of a certain quantity ofthe underlying at a particular price on a particular date, or he can enter into a futures contract for sale of aparticular quantity on a particular date at a particular price and be assured of the margins because bothhis purchase price as well as the sale price are fixed. Whenever they find Gold moving up, they shortsilver and similarly whenever they find silver moving up and gold likely to move down, they hedge.To exporters: Future trading is very useful to the exporters as it provides an advance indication of theprice likely to prevail and thereby help the exporter in quoting a realistic price and thereby secure exportcontract in a competitive market. Having entered into an export contract, it enables him to hedge his riskby operating in futures market.INDIAN COMMODITIES MARKETS: A BIG OPPORTUNITYIndia’s self sufficiency in commodities has brought to the fore its role in developing from an emergingeconomy to a developed one. The commodities market is the “Future investment Market” of India.Even though it is in a nascent stage, it is bound to surpass even the capital market’s trading volumesdue to its core role. It has brought transparency and integrated it into the economy through a structure.The overall Commodity Trading operates through a market structure governed under the ForwardMarket Contracts (Regulation) Act, 1952. Forward Market Commission approves commodities, whichare being traded. Futures contracts are entered into under the auspices of an exchange. Thecommodity markets operate through a list of exchanges in India like Multi Commodity ExchangeNational Multi-commodity Exchange and the National Commodity & Derivatives Exchange Limited .ANMOL FINSEC RIDE THE FUTURE IN COMMODITIESIn order to cater to the growing interest of investors in commodity trading, Anmol Finsec has takendirect membership of all the three leading commodity exchanges of India, namely, NCDEX, MCX andNMCE. Where NCDEX is popular platform for Agro based products, and MCX is popular for bullion.Commodity trading is one of the high potential return-giving instruments in India. Anmol Finsecpossesses the right experience and tailor made solutions to effectively advice on commodity trading. Itis present in the area of future.