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MARKET WATCH : COMMODITIES
Features & Benefits
 

COMMODITY DERIVATES: WHAT & WHY & HOW…

Trading in commodity derivatives commenced primarily with an objective to protect farmers from the risk of the value of their crop going below the cost price of their produce. To begin with derivative contracts were offered on various agricultural products like cotton, rice, coffee, wheat, pepper, etc. The first organized exchange, the Chicago Board of Trade (CBOT) with standardized contracts on various commodities was established in 1848.

 

THE INDIAN SCENARIO…

Commodity derivatives have had a long and a chequered presence in India. The commodity derivative market has been functioning in India since the nineteenth century, with organised trading in cotton through the establishment of Cotton Trade Association in 1875.

Currently there are 3 national level Multi commodity exchanges: National Multi-Commodity Exchange of India (NMCE), National Commodity and Derivatives Exchange (NCDEX) and Multi Commodity Exchange (MCX).

There has been a substantial jump in volumes in the commodities from Rs. 5.71 Lakh Crore in 2004-05 to Rs. 36.77 Lakh Crore in 2006-07.  Currently the Average daily Turnover is about Rs. 12000 - 14,000 Rs. Crore.

 

WHAT ARE DERIVATIVES?

The term "Derivative" indicates that it has no independent value, i.e. its value is entirely "derived" from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, livestock etc. Derivatives can be traded in the form of Futures or Options or its variants.
COMMODITY DERIVATES in INDIA:  Currently only “Futures” contracts are allowed to be traded on the exchanges in India. Futures contract is an agreement to buy or sell the underlying at a specific date, at a specific price for a specific quantity and of a specific quality. There are various commodity futures contracts available for trading currently and to name a few:

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Agricultural Commodities: Soybean, Black Pepper, Jeera Chilly, Turmeric, Guarseed, Mentha oil, Rape/Mustard Seed etc
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Base Metals: Copper, Zinc, Lead, Aluminum, Nickel
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Bullions: Gold, Silver, Platinum
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Energy: Crude Oil, Natural Gas, ATF (Aviation Turbine Fuel)
 

WHY YOU SHOULD LOOK AT COMMODITY DERIVATIVES:

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Core Objective: Commodity derivatives, which were traditionally developed for risk management and arriving at fair price discovery, are now also growing in popularity as an investment tool.
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Direct Exposure: The commodity derivatives market is a direct way to invest in commodities rather than investing in the companies that trade in those commodities. For example, an investor can invest directly in a steel derivative rather than investing in the shares of Tata Steel.
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Simple Analysis: It is easier to forecast the price of commodities based on their demand and supply forecasts as compared to forecasting the price of the shares of a company -- which depend on various factors beyond demand -- and supply of the products they manufacture and sell or trade in.
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Leverage – Small Investment & Bigger Exposure: Derivatives being a leveraged product to invest in it only a small sum of money is required to enter into contract:
Example: An investor buys 1 Contract of Gold (1 Contract = 1 Kg) as he expects prices to go up. Assume MCX Future rate is Rs.13,000/10 Grams. Instead of Spending 13 Lakhs to buy 1 Kg of gold in spot market, he just has to pay a margin amount of 4% - 6% of the contract value to take a position on the future market i.e Rs. 52,000 – Rs. 78,000 and pay the rest only on expiry if he intends to take delivery.
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Hedging: Commodity markets can be used as an effective tool for Producers, Importers, Exporter, etc of the related commodities to hedge their risk and protect themselves against unexpected and uncertain volatile price movements. They can use this market to hedge their raw materials, finished goods, Work in Progress, and closing stocks to some extent which is exposed to fluctuations in prices.
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Portfolio Diversification: For investors, commodities can also be an attractive and alternative asset class to diversify their portfolios. Commodities, especially gold has been observed to have a inverse correlation with the stock markets, indicating that it is an asset looked upon as a safe haven against Financial, Economical and Geo-Political Risks.
 

HOW TO BE A PART OF THIS EVER GROWING MARKET:

Before we look into how investment in a derivative contract works, we must familiarize ourselves with the buyer and the seller of a derivative contract. A buyer of a Commodity derivative contract is a person who pays an initial margin to buy the commodity at a certain price, date quantity and quality date in the future. On the other hand, the seller accepts the margin and agrees to fulfill the agreed terms of the contract by selling the commodity at the agreed price on the maturity date of the contract.

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Open a Commodity Trading account with Sushil Global Commodities
 
Make available the required margin for taking position either Long / Short. Margins may vary from commodity to commodity and from time to time as decided by the exchanges.
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Receive research reports & views on various commodities through SMS, E-Mail & Odin Flash.
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Take position on MCX / NCDEX
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If not interested in taking (Long position) or giving (Short position) delivery then be advised to square up position before expiry especially in case of Compulsory delivery contracts. 
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There is a daily Mark – to – Market (MTM) settlement, hence incase of open position arrange for the payments of any MTM debits, if markets move against the open position.