benefits to industry from futures trading

8/6/2019 Benefits to Industry From Futures Trading

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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 itsstorage.

Efficient price discovery prevents seasonal price volatility.

Greater flexibility, certainty and transparency in procuring commoditieswould aid bank lending.

Facilitate informed lending.

Hedged positions of producers and processors would reduce the risk

ofdefault faced by banks. * Lending for agricultural sector would go upwith

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


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BENEFITS TO EXCHANGE MEMBER

Access to a huge potential market much greater than the securities andcash market in commodities.

Robust, scalable, state-of-art technology deployment.

Member can trade in multiple commodities from a single point, on realTiME BASIS

Traders would be trained to be Rural Advisors and CommoditySpecialists

and through them multiple rural needs would be met, likebank credit,

information dissemination, etc.


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WHAT MAKES COMMODITY TRADING ATTRACTIVE?

A good low-risk portfolio diversifier

A highly liquid asset class, acting as a counterweight to stocks, bondsand real estate.

Less volatile, compared with, equities and bonds.

Investors can leverage their investments and multiply potentialearnings.

Better risk-adjusted returns.

A good hedge against any downturn in equities or bonds as there is

Little correlation with equity and bond markets.

High co-relation with changes in inflation.

No securities transaction tax levied.


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7. INSTRUMENTS AVAILABLE FOR TRADINGIn recent years, derivatives have become increasingly populardue to their applicationsfor hedging, speculation and arbitrage.While futures and options are now actively traded on manyexchanges, f orward contracts are popular on the OTC market. While at the moment only commodity futures trade on theNCDEX, eventually, as themarket grows, we also have commodity options being traded.7.1 FORWARD CONTRACTSA forward contract is an agreement to buy or sell an asset on aspecified date for aspecified price.

One of the parties to the contract assumes a long position and

agrees to buy theunderlying asset on a certain specified futuredate for a certain specified price. The otherparty assumes a short

position and agrees to sell the asset on the same date for

thesame price. Other contract details like delivery date, price and

quantity are negotiatedbilaterally by the parties to the contract.

The forward contracts are normally tradedoutside the exchanges.The salient features of forward contracts are:

They are bilateral contracts and hence exposed to counter-party risk.

Each contract is custom designed, and hence is unique in terms

of contract size, expiration date and the asset type and quality.


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The contract price is generally not available in public domain.

On the expiration date, the contract has to be settled by

delivery of the asset. If the party wishes to reverse the contract, it has to

compulsorily go to the same counterparty, which often results in high prices being charged.

However forward contracts in certain markets have become very

standardised, as in thecase of foreign exchange, thereby reducing

transaction costs and increasing transactionsvolume. This process

of standardisation reaches its limit in the organised

futures market

FUTURES MARKET

F utures markets were designed to solve the problems that exist

in forward markets. Afutures contract is an agreement between

two parties to buy or sell an asset at a certaintime in the future at

a certain price. But unlike forward contracts, the futures

contractsare standardized and exchange traded. To facilitate

liquidity in the futures contracts, theexchange species certain

standard features of the contract. It is a standardized

contractwith standard underlying instrument, a standard quantity

and quality of the underlyinginstrument that can be delivered, (or

which can be used for reference purposes insettlement) and a

standard timing of such settlement. A futures contract may be

offsetprior to maturity by entering into an equal and opposite


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transaction. More than 99% offutures transactions are offset this

way.The standardized items in a futures contract are:

Quantity of the underlying

Quality of the underlying

The date and the month of delivery

The units of price quotation and minimum price change

Location of settlement

Spot price: The price at which an asset trades in the spot

market. F utures price: The price at which the futures contract trades in

the futures market.

OPTIONS

Options are fundamentally different from forward and futures

contracts. An option givesthe holder of the option the right to do

something. The holder does not have to exercisethis right. In

contrast, in a forward or futures contract, the two parties have

committedthemselves to doing something.Whereas it costs nothing (except margin requirements) to enterinto a futures contract,the purchase of an option requires an up-front payment.There are two basic types of options, call options and put options.

Call option: A call option gives the holder the right but not theobligation to buy an asset by a certain date for a certain price.

P ut option: A put option gives the holder the right but not theobligation to sell an asset by a certain date for a certain price.


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H OW T H E COMMODITY MARKET WORKS9.1 WORKING PROCEDURE

The futures market is a centralized market place for buyers and

sellers from around theworld who meet and enter into commodity

futures contracts. P ricing mostly is based onan open cry system,

or bids and offers that can be matched electronically.

Thecommodity contract will state the price that will be paid and

the date of delivery. Almostall futures contracts end without the

actual physical delivery of the commodity.There are two kinds of trades in commodities.The first is the spot trade , in which one pays cash and carriesaway the goods.

The second is futures trade . The underpinning for futures is the

warehouse receipt. Aperson deposits certain amount of say, good

X in a ware house and gets a warehousereceipt which allows him

to ask for physical delivery of the good from the warehouse

butsome one trading in commodity futures need not necessarily

posses such a receipt tostrike a deal. A person can buy or sale acommodity future on an exchange based on hisexpectation of

where the price will go.F utures have something called an expiry date, by when the buyer

or seller either closes(square off) his account or give/take


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delivery of the commodity. The broker maintainsan account of all

dealing parties in which the daily profit or loss due to changes in

thefutures price is recorded. Squiring off is done by taking an

opposite contract so that thenet outstanding is nil.F or commodity futures to work, the seller should be able to

deposit the commodity atwarehouse nearest to him and collect

the warehouse receipt. The buyer should be ableto take physical

delivery at a location of his choice on presenting the warehouse

receipt.But at present in India very few warehouses provide

delivery for specific commodities


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Demat Indicator Delivery process requires9.2.3DELIVERY PROCESS REQUIRES:

Delivery information submitted on Expiry date.

This is done through the delivery request window on the TradingTerminal.

Matching delivery information is obtained.9.2.4VALIDATION OF DELIVERY INFORMATION:

On Client s Net Open P osition

On Delivery lot for commodity

Excess quantity rejected and cash settled


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Matched delivery information9.2.5MATC H ING PARAMETERS:

Commodity

Quantity

Location

Branch

Matching limited to the total warehouse capacity

Settlement through Depository.

Settlement Schedule in Settlement Calendar

Today Commodity trading system is fully computerized. Traders

need not visit a

commodity market to speculate. With online commodity

trading they could sit in the

confines of their home or office and call the shots.

benefits to industry from futures trading

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