commodity futures market in india[1]

8/8/2019 Commodity Futures Market in India[1]

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Commodity Futures Market in IndiaCommodity Futures Market in IndiaGrowth and OpportunitiesGrowth and Opportunities


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COMMODITIES MARKET: BACKGROUNDCOMMODITIES MARKET: BACKGROUND

Started in India in 1875 (Bombay cotton Trade Association)

Banned after Independence in 1952 for unnecessaryspeculation and detrimental to healthy economy.

1960 following drought many farmers defaulted forwardcontracts.

Till 1990: Dormant market which resulted in virtual

dismantling of the commodities future markets

Liberalization of Indian economy in 1991 recognised therole of market and private initiative for the developmentof the economy.


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Scale of operationScale of operation


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COMMODITIES MARKET: BACKGROUNDCOMMODITIES MARKET: BACKGROUND

The year 2003 the real turning point in the policyframework for commodity marketwhen the government issued notifications for withdrawing all prohibitions and opening up forwardtrading in all the commodities

2006 Commodity market crossed 1 trillion mark and stillgrowing.

The current mindset of the people in India is that theCommodity exchanges are speculative (due to nondelivery) and are not meant for actual users.


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Derivative Markets in IndiaDerivative Markets in IndiaDerivative markets can broadly be classified as

financial derivatives andcommodity derivative market .

Commodity derivatives markets trade contracts for whichthe underlying asset is a commodity.

(agricultural commodity or metals like gold, silver, etc.)

Difference: Commodity derivatives & financial derivatives:

1. Due to the bulky nature of the underlying assets,physical settlement in commodity derivatives creates theneed for warehousing.

2. In the case of commodities, the quality of the assetunderlying a contract can vary largely


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Derivative Markets in IndiaDerivative Markets in India contd.contd.Two important derivatives are futures and options.

Commodity Futures ContractsCommodity Options contracts

Major market players in commodities market are: -Hedgers, Speculators, ArbitragersProducers - Farmers

Consumers - refiners, food processing companies, jewellers, textile mills, exporters & importers

[ Mandis (for regulation, dispute settlement) etc]


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NEE D FOR FUTUR E TRADI NG inNEE D FOR FUTUR E TRADI NG incommoditycommodity

Transparent and fair price discovery on account of large-scale participations of entities associated withdifferent value chains.

It reflects views and expectations of a wider section of people related to a particular commodity.

It provides effective platform for price risk managementfor all segments of players ranging from producers, tradersand processors to exporters/importers and end-users of acommodity.


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NEE D FOR FUTUR E TRADI NG inNEE D FOR FUTUR E TRADI NG incommoditycommodity

Help in improving the cropping pattern for the farmers,thus minimizing the losses to the farmers.

Smart investment choice by providing hedging, tradingand arbitrage opportunities to market players.

Historically, pricing in commodities futures has been lessvolatile compared with equity and bonds, thus providingan efficient portfolio diversification option.


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KEY FACTORS: COMMODITY FUTURESKEY FACTORS: COMMODITY FUTURES

The commodity should be competitive,

There should be fluctuations in price.

The market for the commodity should be free fromsubstantial government control.

The commodity should have long shelf life and be

capable of standardisation and gradation.


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Key Problems : Commodities MktKey Problems : Commodities MktInstitutional issues have resulted in very few deliveriesso far.

There are a lot of hassles such as octroi duty, logistics.

If there is a broker in Mumbai and a broker in Kolkata,transportation costs, octroi duty, logistical problemsprevent trading to take place.

E xchanges are used only to hedge price risk on spottransactions carried out in the local markets.

Multiple restrictions exist on inter-state movement andwarehousing of commodities.


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Key Risks : Commodities MarketsKey Risks : Commodities Markets

Key Risk associatedthe price risk

the quantity risk,the yield/output risk and

Risk mitigation : -Initial MarginsE xposure marginsMarket to market of positions on a daily basisPosition Limits and Intra day price limitsSurveillance


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COMMODITY FUTURES EXCHANGE : INDIACOMMODITY FUTURES EXCHANGE : INDIA

Electronic trading and settlement systems in India:

i) N CD EX (N ational Commodity and DerivativeE xchange),

ii) MCX (Multi Commodity E xchange of India Ltd)iii) N MCE IL (N ational Multi Commodity E xchange of

India Ltd.)

22 exchanges and trading boards recognised byForward Markets Commission (FMC), the marketregulator.


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MCX: COMM. ECOSYSTEM & STRUCTUREMCX: COMM. ECOSYSTEM & STRUCTURE


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MCX:Commodity Market StructureMCX:Commodity Market Structure


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MCX MCX

INVE STM EN T LIMIT AN D MAR G IN Amount as low as Rs 5,000 as money for margins (5-

10% of the value of contract.) payable upfront toexchanges through brokers.

It uses SPA N (Standard Portfolio Analysis of Risk)system which follows a risk-based and portfolio-basedapproach. The Initial Margin requirement is

BROK

ERA

GEA

ND TRA

NSACTIO

NCHAR

GESRanges from 0.10-0.25 % of the contract value

Transaction charges range between Rs 6 and Rs 10per lakh/per contract. The brokerage cannot exceed themaximum limit specified by the exchanges.


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Settling Commodity Future ContractSettling Commodity Future Contract

Commodity Futures contracts are usually not settledwith physical delivery. The purchase or sale of anoffsetting position can be used to settle an existingposition, allowing the speculator or hedger to realizeprofits or losses from the original contract. At this point

the margin balance is returned to the holder along withany additional gains, or the margin balance plus profitas a credit toward the holder's loss.

Cash settlement is used for contracts like stock or index futures that obviously cannot result in delivery.The purpose of the delivery option is to insure that thefutures price and the cash price of good converge atthe expiration date.


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Advantages of Futures Trading Advantages of Futures Trading

High Leverage . the potential for large profits in a short period of time.The reason that futures trading can be so profitable is the high leverage. Toown a futures contract an investor only has to put up a small fraction of thevalue of the contract (usually around 10-20%) as margin.

Profit in both bull & bear markets . it is as easy to sell as it isto buy. By choosing correctly, you can make money whether prices go up or down. Therefore, trading in the futures markets offers the opportunity toprofit from any potential economic scenario. Regardless of whether we haveinflation or deflation, boom or depression, hurricanes, droughts, famines or freezes, there is always the potential for profit making opportunities.

Lower transaction cost.

High liquidity


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COMPARATIVE ANALYSIS OF COMMODITYCOMPARATIVE ANALYSIS OF COMMODITYAND EQUITY MARKETSAND EQUITY MARKETS

F C M E M

PercentageReturns

Gold gives 10-15 % returns on the conservativebasis.

Returns in the range of 15-20 % on annualbasis.

Initial Margins Lower in the range of 4-5-6% Higher in the range of 25-40%

ArbitrageOpportunities

Exists on 1-2 month contracts. There is a smalldifference in prices, but in case of commodities,which is in large tonnage it makes a hugedifference.

Significant Arbitrage Opportunities exists.

Price Movements Price movements are purely based on the supplyand demand.

Prices movements based on theexpectation of future performance.

Price Changes Price changes are due to policy changes,changes in tariff and duties.

Price changes can also be due to Corporateactions, Dividend announcements, Bonusshares / Stock splits.

FuturePredictability

Predictability of future prices is not in the controldue to factors like Failure of Monsoon andFormation of El-ninos at Pacific.

Predictability of futures performance isreasonably high, which is supplemented bythe History of management performance.

Volatility Lower Volatility Higher Volatility

SecuritiesTransaction Act

Application

Securities Transaction Act is not applicable tocommodity futures trading.

Securities Transaction Act is applicable toequity markets trading.


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INDIAS PLACE IN WORLDINDIAS PLACE IN WORLDMARKETMARKET

COMMODIT INDIA WORLD S ARE RANKRICE (PADDY) 240 2049 11.71 THIRDWHEAT 74 599 12.35 SECOND

PULSES 13 55 23.64 FIRSTGROUNDNUT 6 35 17.14 SECONDRAPESEED 6 40 15.00 THIRDSUGARCANE 315 1278 24.65 SECONDTEA 0.75 2.99 25.08 FIRSTCOFFEE(GREEN) 0.28 7.28 3.85 EIGTHJUTE AND JUTE FIBERS 1.74 4.02 43.30 SECONDCOTTON (LINT) 2.06 18.84 10.09 THIRD


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BUSINESS POTENTIALBUSINESS POTENTIAL


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MCX & OTHER BULLION EXCHANGESMCX & OTHER BULLION EXCHANGES

(Approx. figs.) MC X N YMEX TOCOM

Contract Size (grams) 1000 3110 1000

Benchmark Market Mumbai N ew York Tokyo

Operational Cost Low High High

Transaction cost 0.01 % 0.08 0.1 % 0.4 %

Channel Trade Transparency High Low Low

Channel Financial Integrity High Low Low

Lead Transaction Time Low High High

Physical Delivery Yes N o N o

Analysis of opportunity in bullion market with respect to other major exchanges as been shown below:


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Growth ProspectsGrowth Prospects

ith the gradual withdrawal of the government from various sectors in thepost-liberalization era, the need has been felt that various operators in thecommodities market be provided with a mechanism to hedge and transfer their risks. India's obligation under TO to open agriculture sector to worldtrade would require futures trade in a wide variety of primary commoditiesand their products to enable diverse market functionaries to cope with the

price volatility prevailing in the world markets.G

overnment subsidy may godown as a result of TO. The MSP programme will not be sustainable insuch a scenario. The farmer will have to look at ways of being in a positionto trade on commodity exchanges in future. Also, corporates will feel thepressure to hedge their price risk once the frontiers open up for free trade.Indian markets have recently thrown open a new avenue for retail investorsand traders to participate: commodity derivatives. For those who want todiversify their portfolios beyond shares, bonds and real estate, commoditiesare the best option.Options contracts in commodities are being considered and this wouldagain boost the commodity risk management markets in the country.


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Other AdvantagesOther Advantages Apart from above following are promising features that makes Indiancommodity future market attractive:

Better Reach in all parts of the countryider base for speculators from other markets including securities

marketBroad basing of the underlying commodityIndustry diffused in several parts of the country may also directlyparticipateFew commodities can be projected viable for an international futuresContract, with participation from global player N ovation of all open positions in the market by the exchangeBest management practices, end of day mark to market, onlinemargining and surveillance, daily pay-in & pay-out are some of thefeatures to woo the players


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commodity futures market in india[1]

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