Commodity - FAQs

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What is Commodity Market ?

Commodity market is a marketplace for facilitating trading in different commodities. Market can be a derivative or spot market. In the derivatives market, different financial instruments like futures and options are specifically traded based on the commodities. On the other hand, in spot market commodities are sold and brought for the immediate delivery. Such financial instruments like ‘futures’ are often traded in the online commodity exchanges.

Commodity Futures are the contracts for selling or buying particular quantity of the specific commodity at the future date. It is quite similar to the Stock futures and Index futures but underlying occurs to be the commodities in place of indices and Stocks.

Future trading is known as trading of the future contract. The future contract purchaser possesses the right to buy commodity of similar quality, quantity in particular time period from seller of the contract.

  • Fair Price Discovery and Transparency: Trading in the commodity futures is often considered as transparent and through the large-scale participation; fair price discovery process is confirmed as well. Also large participation illustrates expectations and the views of the wider section of people who are concerned with the commodity.
  • Online platform: Processors, traders and producers along with importers or exporters for the purpose of managing price risk widely use the online platforms offered by NCDEX/MCX.
  • Hedging: It gives form to the producers in order to hedge positions based on their exposure within the physical commodity.
  • Simple Economics: The mechanism of commodity trading is depended on the simple economics that is, supply and demand. The price of the commodity is quite higher if its demand is higher and vice versa.
  • Low margins: Future traders of the commodity are needed to deposit quite low margins; roughly it is 5% to 10% of the contract’s total value, which is much lower in comparison to other classes of asset.
  • No counter party risk: Commodity Futures possesses Clearing Houses, just like exchanges within equity market that confirm the fact that contract terms totally fulfils and thus is responsible for eliminating the risk associated with the counter party.
  • Wide participation: The emergence of online trading enabled a wide expansion within the commodity market over the years.
  • Evolved pricing: The development in the participation could minimize risks of the cartelization, confirming the holistic perspective towards the commodity. Thus, pricing can be more or less irrational and more practical resulting in the Discovery Mechanism of fair price.

The SEBI oversees and regulates the Indian commodity market.

  • Farmers/Investors
  • Investors
  • Exporters/Importers.
  • Agencies providing agricultural credit
  • Commodity financers
  • Large scale consumers like jewelers, refiners, textile mills
  • Arbitrageurs, Speculators, Hedgers
  • Corporate possessing risk exposure in the commodities

Commodity Exchange is the market place where the commodity trading is taken place. Currently, there are three exchanges of national-level within the country where commodity trade can take place like National Commodity and Derivative Exchange (NCDEX), Multi Commodity Exchange of India LTD (MCX) and National Multi Commodity Exchange of India Ltd (NMCE). There are 21 smaller exchanges as well offering the commodity trading at regional level.

Investors have lot of choices when participating in commodity market. There are different types of metals like Gold, Silver, Copper, etc. Energy counters like Crude oil and Natural Gas are also traded. A number of agriculture commodities like Chana, Soybeans, Turmeric, Wheat etc are also available for trading.

In the market of derivatives, an individual only pays very small portion for the actual trade value. In this case, it is not required to pay for the whole sum upfront like the purchasing of stocks or the spot market. This is known as the Margin. More simply, the Margin is understood as the amount an individual is needed to deposit with the broker earlier to performing any kind of commodities trade on any type of exchange.

Each value of trades and contracts are often adjusted for reflecting the current price of market. This is known as Mark to Market (MTM). Also, the very day when an individual enters into the futures contract, MTM or Mark to Marketing is considered as the very difference between closing price of the day and the entry value. In the context of carried forward position or stature, it is considered as the difference between the market price of day and closing price of the earlier day

A hedge is considered as the investment mitigating the very risk of adverse movements of price of any asset. Commodity prices often keep on fluctuating. In order to hedge against such price risks, players are required to sell or buy positions in the futures markets of commodity. It is primarily the sellers/producers of the commodities for e.g., farmers’ producing wheat and the bulk buyers/consumers of the commodities (like the manufacturers of bread who utilize the wheat as raw material) that are undertaking hedging in various commodities.

Warehouse receipts are known as titled documents that are issued by the warehouses to the depositors against much deposited commodities. Through delivery and endorsements such documents are transferred. Such commodities can be claimed only by the receipt holders from warehouses.

When in Commodity Futures Market, an individual trades, that person possesses standardized contract. This means, every trade possesses certain common characteristics.

Such common quality is prescribed by Lot Size. The individual is thus responsible for trading in the multiples of such quantity or the lot.

However, delivery quantity can differ from the size of minimum lot. This is known as Delivery size.

Thus, for example, if the size of delivery was 200 gms and one lot for the commodity was 100 gms, then the individual requires for the trading at least in two lots for being eligible for the delivery

Contango is a situation where the futures price of a commodity is above the expected spot price. Contango refers to a situation where the future spot price is below the current price, and people are willing to pay more for a commodity at some point in the future than the actual expected price of the commodity. This may be due to people's desire to pay a premium to have the commodity in the future rather than paying the costs of storage and the carry costs of buying the commodity today.

This is considered as the very opposite of Contango. This occurs when the futures price is lower than the commodity’s spot price therefore, backwardation opines that future expiration of contracts will be traded at higher price comparing to the expiration of contract.

This is considered as the difference between future prices of specific commodity over various tenures. For example, commodity’s future price may be Rs. 100 for the contract of 1 month and for 2 months contract Rs. 110. Such Rs 10 difference is known as Spread.

Commodity prices normally tend to respond to the expected trends in demand and supply. For agriculture commodities, seasonal patterns, weather conditions, stock levels in major mandies and arrivals also play a critical role in daily price variations. For commodities like Gold, Silver, Copper, Crude etc, global price movement in these commodities, cues from currency markets and the general global economic conditions shape up the price behaviour.


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