Commodity trading has undergone tremendous changes, from the barter system to spot markets to futures markets. The major steps towards introduction of futures trading in commodities were initiated in 2004 with the removal of prohibition on futures trading in all recommended commodities and the setting up of commodity exchanges at the national level. Since then, the commodity future markets have witnessed a rapid increase in trading volumes, market participation and the number of commodities traded. The commodity futures were initially permitted to trade in agricultural products but nowadays bullion, metals and energy products dominate the trading volume.

1. BASICS OF COMMUDITY
FUTURES
Ankita
F-2015-02-M
Deptt. Of social sciences
Dr. YS Parmar UHF Nauni Solan(H.P.)

2. Introduction
Commodity trading has undergone tremendous
changes,
from the barter system to spot markets to futures
markets.
The major steps towards introduction of futures trading
in
commodities were initiated in 2004 with the removal of
prohibition on futures trading in all recommended
commodities and the setting up of commodity
exchanges at
the national level. Since then, the commodity future
markets have witnessed a rapid increase in trading
volumes,

3. Commodity Futures
 Commodity future contracts are agreements made on
a futures exchange to buy or sell a commodity at a
pre-determined price in the future.
 The futures contracts are traded on regulated
exchanges and the terms of the contract are
standardized by the exchange.
 Only price is negotiated by the counterparties (buyer
and seller of a futures contract). The price is
discovered through the offers and bids process.
 All contracts are settled by cash or physical delivery
of the underlying commodity on the expiry date of the
contract. In Indian exchanges, almost all commodity
futures contracts are cash-settled.

5. Functions of Commodity Futures
Trading
 The two major economic functions of a commodity
futures trading are price risk management and
price discovery. A futures exchange carries out
these twin functions by providing a trading platform
that brings buyers and sellers together.
 Price risk management is the transfer of price risk
from a hedger to a speculator.
 Price discovery is a continuous process of arriving
at a price at which a person buys and another sells
a futures contract in a commodity exchange.

7. Commodity Categories
 Grains and oilseeds: Wheat, corn, oats, soybeans, soybean
meal, soybean oil, barley, rice.
 Livestock and meat: Cattle, feeder cattle, hogs, pork
bellies.
 Dairy products: Milk, butter, nonfat dry milk.
 Foods and fibers: Including sugar, cocoa, coffee, cotton.
 Wood and petroleum: Including lumber, crude oil, heating
oil, gasoline.
 Metals: Including gold, silver, copper.
 Energy: Including oil, natural gas, electricity.
 Events: Including unemployment rate, inflation, GDP.

9. Commodities suitable for
Futures Trading
 There should be large demand for and supply of
the physical commodity and no individual or group
of persons acting in concert should be in a position
to influence the demand or supply, and
consequently the price substantially.
 There should be fluctuations in prices of that
commodity. If the prices of a particular commodity
are relatively stable, there is very less price risk
involved in that commodity.
 The market for the physical commodity should be
free from substantial government control.

10.  The commodity should have long shelf life.
 The commodity should be capable of
standardization and gradation.
 The regulatory authorities should have powers and
willingness to enforce new regulations and laws.
 The delivery points where farmers need to
physically deliver the commodity should not be too
far away from the harvest place.
 The commodity should also have substantial price
volatility, because it is the hedger’s need for risk
management that ultimately fuels trading.

11. Participants
 Brokerage firms place orders to buy and sell futures
and options contracts for companies or individuals.
Firms earn a commission on all transactions. Everyone
who trades must have an account with a brokerage
firm.
 Floor traders are members of an exchange. They buy
and sell contracts on the floor of the exchange in open
outcry . All trading is done publicly so each trader has a
fair chance to buy and sell. There are two types of
traders on an exchange floor:
Floor traders: People who trade for themselves or the
accounts they control, using different trading strategies.
Floor brokers: Floor brokers act as agents for
customers by trading futures and options contracts on
the floor of an exchange for other people.

12.  E-traders: With the introduction of electronic trading
platforms, traders no longer need to be physically
present on the floor.
 Commodity Pool Operators: CPOs pool investors’
funds and operate much like a mutual funds for
stocks. Because these funds can make large trades,
they can have a significant impact on individual
futures markets and on price trends.
 Speculators try to make money by buying and selling
futures and options. They do not intend to make or
take delivery of the commodities. Speculators
assume the risk in the market and provide liquidity.

13.  Hedgers are people or firms who use futures or
options as a substitute for buying and selling the
actual commodity. They buy and sell contracts to
offset the risk of changing prices in the cash markets.
Hedgers use futures to transfer risk to speculators.
The futures markets exist primarily for hedgers.

14.  Regulators oversee the working of the exchange. The
Forward Markets Commission (FMC) is the regulatory
authority for the commodity futures market in India. It is
equivalent of the Securities and Exchange Board of
India (SEBI), which regulates the equity markets in
India.

15. Role of an exchange in futures trading
 The exchange provides a seamless trading platform and
competitive trading as well as facilities for clearing,
settlement, and arbitration. Above all, the exchange
guarantees a financially secure environment for risk
management and guaranteed performance of contract.
major commodity exchanges in India
 Multi Commodity Exchange of India (MCX), Mumbai.
 National Commodity and Derivatives Exchange of India
(NCDEX), Mumbai.
 National Multi Commodity Exchange (NMCE),
Ahmedabad
 Indian Commodity Exchange (ICEX), New Delhi.
 ACE Derivatives & Commodity Exchange Limited,

16. Farmer’s participation in the Indian
Commodity Future Markets
Farmer’s participation in the Indian Commodity Future
Markets is very low. There are several reasons behind the
low participation of farmers and their representative
institutions in the Indian futures markets, some of which
are listed below:
 Farmers cannot afford to pay the fees for maintaining
trading account with the brokers besides warehousing
and assaying costs.
 Farmers find the trading requirements such as payment
of margins to be burdensome.
 The minimum lot size for trading in the futures market is
much larger than the marketed surplus for most of the
farmers in India. As a result, marginal/small farmers who
need risk coverage the most are totally excluded.

17.  They lack the skills needed for trading on electronic
exchanges.
 The trading terminals are yet to penetrate into villages
as the necessary infrastructure (power supply and
broadband) is still missing in rural India.
 The absence of the appropriate scale and quality of
warehousing infrastructure and grading facility.

18. Advantages of Future Contract
 Easy to enter/exit.
 Minimize risk.
 Often better prices.
 Transparency in market transactions and
prices.
 High liquidity – easy exit before maturity.
 Absence of credit and counter party default.
 Easy and convenient access to all market
participants.

19. Disadvantages
 Opportunity loss if prices rise.
 Performance bond calls.
 Set quantities.
 Non availability of future contracts in some
commodities.

20. Regulation
Both the exchanges and the government
play a role in regulating futures market
activity.
A supervisory framework for futures markets
is needed to ensure that market participants
don’t indulge in manipulation and other
kinds of market abusive practices. A well-
designed regulatory regime improves
transparency, efficiency and market
integrity.
Regulations also help futures market
achieve their twin objectives of price
discovery and price risk management in an
efficient and orderly manner.

21. Regulation in India
 At present, the regulation of commodity futures
markets is carried out through a three-tiered
regulatory structure - the central government, the
Forward Markets Commission (FMC) and the
commodity exchanges.
 The FMC, headquartered at Mumbai, is the
regulatory and supervisory authority for commodity
futures market in India. It is a statutory body set up
under Forward Contracts (Regulation) Act, 1952.
 It now functions under the administrative control of
the Ministry of Finance.

22. Conclusion
 Futures contracts have evolved over the years. But
successful futures contracts – those with adequate
volume for both hedgers and speculators – generally
have certain features in common.
 Large cash commodity market with a substantial
deliverable supply and easily available, up-to-date price
information will prevent market manipulation.
 Futures trading evolved from the circumstances and
needs of the markets, and it is still changing today.
Some commodities have been traded for over a
hundred years, some have been dropped from the
exchanges for lack of trading activity, and others have
been added only recently.

23. References
 CME commodity trading manual.
 Neeraj Mahajan, Kavaljit Singh. “Understanding
derivatives and Commodity Futures Trading”, A
Beginner’s Guide to Indian Commodity Futures
Markets.
 A Trader’s Guide to Futures.