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By: Sudama Thakur & Sudarshan Kr.Patel

FUTURE TRADING

Flow of Presentation

• Introduction• Global scenario• Indian scenario• Commodity• Trading parameter• Uses of commodity futures• Margin, Clearing & Settlement• NSEL fiasco• Regulatory framework• Conclusion.

Future trading :DEFINITION

“Futures” are standardized forward contracts traded on

regulated exchanges.

A futures trading is a central financial exchange where people can trade standardized futures contracts; ie, a contract to buy specific quantities of a commodity or financial instrument @ specified price with delivery set at a

specified time in the future.  

Standardized ContractStandardized ContractSe

llBuy

Specified Asset

history

Aristotle's Politics -earliest written records of futures trading .

Dojima Rice Exchange in Osaka, Japan- 1st modern organized futures exchange began in 1710.Chicago Board of Trade (CBOT) - 1848

Bombay Cotton Trade Association - 1875 (First organized Exchange in India ) Forward Contracts (Regulation) Act passed in 1952

National Stock Exchange of India in Mumbai - largest in the world

Difference between Commodity & Derivatives

* Commodity- is a marketable item produced to satisfy wants or needs.

* Derivative -

A derivative is basically a financial instrument whose value is derived from the value of an underlying security. Examples of derivatives include:

• Forward contracts - A cash market transaction where the delivery of the asset underlying the contract is deferred until a future date. Contracts are not standardized, as they are an agreement between two parties.

• Futures contracts - A financial contract that obligates the buyer to purchase (or in the case of a seller, to sell and deliver) the assets underlying the contract at a certain future date. Since they trade within secondary markets, the contracts are standardized.

• Options - A privilege sold by one party to another offering the holder the right, but not the obligation, to buy (call) or sell (put) a security at the strike price at a certain time.

• Swaps - The exchange of one security, currency or interest rate for another.

Functions of an exchanges :

•The “main functions” of an Exchange traded futures contract are –

Trade Guarantee Risk Management Price Discovery Transactional Efficiency Liquidity

Steps taken by investor:

Long Futures Position – An investor who has agreed to buy Short Futures Position – An investor who has agreed to sellFutures Price – The price agreed by the two traders on the floor of the exchange

ParticularsSpot Trading

Forward Trading

Futures Trading

Definition trading, clearing and settlement happens instantaneously, i.e. 'on the spot'.

agreement between two entities to buy or sell the underlying asset at a future date, at today's pre-agreed price.

agreement between two parties to buy or sell the underlying asset at a future date at today's future price.

Structure Doesn’t standardized.

Doesn’t standardized.

standardized trading.

Market regulation

Not regulated Not regulated Govt. regulated market

Transaction method Negotiated directly

Negotiated directly by the buyer and seller

Quoted and traded on the Exchange• Source-National Stock Exchange of India Ltd.

Global Commodity Derivatives Exchanges

• In the US, the development of modern futures trading began in the early 1800s.

• First forward contracts were in corn.

• The earliest recorded forward contract was on March 13, 1851-Chicago Board of Trade (CBOT)

• The Buenos Aires Grain Exchange in Argentina (founded in 1854) is one of the oldest in the world.

S.No. Exchange Main Commodities Traded

1 NYMEX Crude oil, Natural Gas, Gold

2 CBOT Corn, Soybean, Wheat, Soybean oil

3 ICE, US Sugar, Coffee, Cotton, Cocoa

4 CME Live Cattle, Lean Hogs, Feeder Cattle

5 Shanghai Futures Exchange Copper, Rubber, Fuel oil, Zinc, Aluminium• Source-National Stock Exchange of India Ltd.

Need for Commodity Exchanges in India

Major worldwide consumer/producer, importer/exporter of various

commodities owing to its huge population

Largest consumer of Bullion (Gold & Silver)

Potential of becoming a major commodity trading hub

Efficient trading platform for uniform price mechanism for

commodities being traded nationally

Favorable demographics (around 65% below 35 years) would

provide major consumer base in future

Indian Commodity Exchanges

,ICEX

Indian Commodity Exchanges

There are more than 20 recognised commodity futures exchanges in India under the purview of the Forward Markets Commission (FMC).

The country's commodity futures exchanges are divided majorly into two categories:-

Regional exchanges National exchanges:

i) National Commodity and Derivatives Exchange of India Ltd. (NCDEX)ii) National Multi Commodity Exchange of India Ltd. (NMCE)iii) Multi Commodity Exchange of India Ltd. (MCX)iv) Indian Commodity Exchange Ltd. (ICEX) which started trading operations on November 27,2009.

• Source-National Stock Exchange of India Ltd.

MCX

ICEX

Share of agricultural commodities trade in exchanges (2009-10)

S.No.Exchanges Share (%)

1.NCDEX 47

2.MCX 27

3.NBOT 9

4.NMCE 2

5.Others 15

47%

27%

9%

2%15% NCDEX

MCX

NBOT

NMCE

Others

Source: Forward Markets Commission

The share of various Exchanges in the total value of trade -2011-12.

Name of the Exchanges Value in Rs. cr. % share to the total value of the commodities traded

MCX 15597095.47 86.04

NCDEX, Mumbai 1810210.10 9.98

NMCE, Ahmedabad 268350.95 1.48

ICEX, Mumbai 258105.67 1.42

ACE Ahmedabad 138654.61 0.76

Total of five Exchanges 18072416.80 99.70

Others 53687.00 0.30

Grand Total 18126103.80 100

Source: Forward market commission

Commodity Futures Trade in India (FY2012-13)

Category April to Feb FY2012-13 %aseTotal ` 157.828 lakh cr 100

Bullion ` 73.26 lakh cr. 46.42

Agri ` 20.203 lakh cr. 12.80

Metals ` 29.951 lakh cr. 18.97

Energy ` 34.4 lakh cr. 21.81

• http://www.commodityonline.com• FMC

46.42%

12.80%

18.97%

21.81%

Bullion Agri

Metals Energy

Commodities

.

Commodities Traded at ExchangesEnergy• Crude Oil• Brent Crude Oil• Furnace Oil• Natural Gas• Carbon CreditsOils and Oilseeds• Soy Seed & Meal• Castor Seed & Oil• Mustard Oil• Sesame Seed• Crude Palm Oil• Groundnut Oil• RBD Palmolein• Cotton Seed & Oilcake• Refined Sunflower Oil• Coconut OilJaggery Gur Sugar S-30 Sugar M-30

Bullion Gold – 1 kg, 100 gm,8 gm Silver – 30 Kg, 5 Kg PlatinumFibreCotton–Medium StapleCotton – Long StapleKapasCotton-Short StaplePulsesMasur (Masra)Yellow PeasMetalsCopperAluminumZincTinNickel LeadSponge IronSteel flat/Long

Plastics Polypropylene HDPE PVCCereals• MaizePlantation• CoffeeSpices Black Pepper Cumin Seed (Jeera) Red Chilli Turmeric Cardamom

Others Cashew Kernel Guarseed /Gum Mentha Oil Arecanut

contd….

No. Exchanges Main Commodities

1 MCX Gold, Silver, Copper, Crude Oil, Mentha Oil, Crude_Palm_Oil, Refined Soya Oil, Cardamom, Guar Seeds, Kapas, Potato, Chana\Gram, Melted Menthol Flakes, Almond, Wheat, Barley, Long Steel, Maize, Soybean Seeds, Natural gas

2 NCDEX Guar Seed, Soy Bean, Soy Oil, Chana, Jeera, Turmeric, Guar Gum, Pepper, Cotton Cake, Gur, Kapas, Wheat, Red Chilli, Crude Oil, Maize, Gold, Copper, Castor Seeds, Potato, Barley, Kachhi Ghani Mustard Oil, Silver.

3 NMCE Rape/Mustard Seed, Guar Seeds, Nickel, Jute, Refined Soya Oil, Zinc, Rubber, Chana\Gram, Isabgul, Lead, Gold, Aluminium, Copper, Turmeric, Copra, Silver, Raw Jute, Guar Gum, Pepper, Coffee Robusta, Castor Seeds, Mentha oil

4 ICEX Gold, Crude Oil, Copper, Silver

Futures Trading System

• It provides a fully automated screen-based trading for futures• On commodities on a nationwide basis as well as an online

monitoring and surveillance mechanism. • It supports an order driven market and provides complete

transparency of trading operations.

Commodity Futures Trading Cycle

This refers to the period within which the futures contract must be fulfilled.

Futures contracts having 1-month, 2-month, 3-month and more (not more than 12 months) expiry cycles.

Most of the futures contracts (mainly agri commodities contract) expire on the 20th of the expiry month.

Trading Parameters Permitted Lot SizeIt is stipulated by the Exchange from time to time.

Tick size• It is the smallest price change that can occur for the trades on the Exchange• For example: in case of refined soy oil, it is 5 paise, Wheat 20 paise and Jeera

Re 1.Ticker symbol: It is a system of letters that are used to identify a commodity

Currently applicable lot size & other parameters for NCDEX are:

source:www.ncdex.com

Quantity Freeze

• Order of the quantity specified by the Exchange.• Any order exceeding this specified quantity will not be executed

but will lie pending as a quantity freeze.

Base Price• is the previous days' closing price of the underlying commodity

in the prevailing spot markets

source:www.ncdex.com

Use of Commodity Futures

• Hedging• Speculation• Arbitrage

Type of Traders

Hedger-use commodities futures and options to limit the price risk of the physical asset

-Risk mitigator

Speculators –

-They wish to take a position in the market by betting that either the prices will go up or go down -Risk taker

Arbitrageurs- -They involve in making riskless profits by simultaneously entering into transactions in two or more markets.. -Price stabilizer

Margins For Trading In Futures

Margin is the deposit money that needs to be paid to buy or sell each contract.

The margin levels are set by the exchanges based on volatility (market conditions) and can be changed at any time.

The margin requirements for most futures contracts range from 5% to 15% of the value of the contract, with a minimum of 5%, except for Gold where the minimum margin is 4%.

Clearing & Settlement Most futures contracts do not lead to the actual physical delivery of the underlying

asset. The settlement is done by closing out open positions, physical delivery or cash

settlement. All these settlement functions are taken care of by an entity called clearing house.Clearing• To keep track of all the transactions that take place during a day so that the net

position of each of its members can be calculated.• It guarantees the performance of the parties to each transaction.• For effective timely settlement.Settlement

Futures contracts have two types of settlements:(i)The Mark-to-Market (MTM) settlement which happens on a continuous basis at the end of each day.(ii)The final settlement which happens on the last trading day of the futures contract.• Settlement involves payments (Pay-Ins) and receipts (Pay Outs) for all the

transactions done by the members.• The MTM profit and loss is settled through pay in/ pay out on T+1 basis, T being the

trade day.

NSEL fiasco

• February 6,2012 : FMC Named as a designated agency for spot markets. It asks for trade data from spot exchanges in prescribed format and finds violations by NECL.

• April 27,2012 : The Consumer affairs ministry issue a show cause notice to NSEL on violation of conditions.

• July 10,2012 : Consumer Affairs Secretary holds meeting with spot exchanges(NSEL, NCEDX) seeks an undertaking from NSEL, that under /fresh contracts will be launched until further instructions and all existing contracts will be settled on the due dates.

• July 22,2012 : NSEL submits an undertaking note to launch any further/fresh contracts in new commodities.

• July 31,2012 : NSEL announces that trading in all contracts , except e-series contracts ,stands suspended

• Aug 6,2013 : NSEL suspends trading in e-series• Aug 14,2013 : Exchange announces payment schedule spanning over 30 weeks• Aug 20,2013 : NSEL defaults first payment schedule.

Regulatory framework

• The Forward Markets Commission (FMC) is the Regulatory Authority for futures market under the Forward Contracts (Regulation) Act 1952.

• 3 tier system followed in India:

Govt. of IndiaFMC

Commodity Exchanges

Regulation required to:-• Create competitive conditions• Prevent price manipulation• Introduce a risk management system• Ensure fairness and transparency • Protect and promote interest of various stakeholders including non- member users

.a. Rules governing Commodity Derivatives Exchanges Forward Contracts (Regulation) Act,1952 Recognized by Central Govt. Dept. Of Consumer Affairs Obtain certificate of registration from the FMC Other laws like: Companies Act, Stamp Act, Contracts Act, etc.

b. Rules governing Intermediaries Trading members & users, trade cycle, trading parameters, failure of

member terminal, trade operations, margin requirements. clearing and settlement process, depository .

c. Rules governing Investor grievances, Arbitration

Summary : Future trading

Future trading allows to go long (buy and sell) and short (sell and buy back) trades.

Time frame to hold the stock will be till the last Thursday of the month.

Derivative trading discounts the price for every lot. Contracts can be exercised anytime till expiry. Future trading is available in nifty and stocks. Used to trade in combination with other segments

like cash to hedge. Profit and losses in future trading are high when

compared with cash trading.

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