ABCs of commodities trading

THE investment universe has, for long, consisted of stocks, bonds, fixed
deposits, mutual funds, jewellery and real estate.

The lifting of the 30-year ban on commodity futures trading in India has opened
yet another avenue for investors. Want to know how to go about trading in
commodity futures but do not know whom to ask? Read on...

Where can I trade on commodity futures?

Commodity futures are traded in commodity exchanges and popular online

exchanges such as the Multi Commodity Exchange (MCX), the National
Commodity and Derivatives Exchange (NCDEX), the National Multi-Commodity
Exchange (NMCE) and the National Board of Trade (NBoT) in India. These are
platforms on which market participants come together to effect their trades.

The NCDEX and the MCX are located in Mumbai, the NMCE in Ahmedabad and
the NBoT in Indore. These exchanges are promoted by leading banks: The
NCDEX is co-promoted by the NSE; the MCX by the SBI group; and the NMCE by
the Central Warehousing Corporation. Various stockbrokers, including Geojit,
Motilal Oswal and India Infoline, provide commodity trading services. Most
brokers take orders over the phone.

How do I initiate a trade?

Investors are required to open a trading account with a broker or sub-broker;

documents establishing address and identity proof are required. While brokers
vary on the documents required for proof, most insist on a PAN card as proof of
photo identity. Bank account details are also asked for enabling remittance and
payment.

In the case of a company, resolution of the board authorising participation in

derivatives trading would have to be produced; for firms, a copy of the
partnership deed would also be required. Those who want to give or take
physical delivery for a contract on the MCX and the NCDEX are additionally
required to open a demat account with NSDL or CDSL, apart from providing local
sales tax registration details of the delivery centre.
What commodities can I trade in?

The FMC (Forward Markets Commission) approves commodities that can be

traded. Commodities available for trading include bullion — gold and silver;
metals — steel, copper, aluminium, lead and nickel; crude; and several agri
commodities. However, not all commodities are traded on all these exchanges;
while crude, gold and silver are highly traded on the MCX, agri commodities are
traded more on the NMCE and the NCDEX.

What are the features of a contract in commodity futures?

Commodity future contracts are tradeable standardised contracts, the terms and
conditions of which are set in advance by the exchanges regulating the trade.
The commodities are required to meet certain pre-set quality specifications; in
the case of gold, for example, on the NCDEX a minimum fineness of 0.995 and a
serial number of an approved refiner.

Each contract has a lot size and a delivery size, which are not the same; in the
case of gold, the lot size on the NCDEX is 100 gm while the delivery size is 1000
gm. If a person wants to enter into a delivery settlement for gold, he will have to
enter into a minimum of 10 contracts or multiples thereof. Market participants
are required to negotiate only the quantity and price of the contract, as all other
parameters are predetermined by the exchange.

How to settle a transaction?

A settlement takes place either through squaring off your position or by cash
settlement or physical delivery. Squaring off is taking a contrary position to the
initial stance, which means in the case of an original buy contract an investor
would have to take a sell contract.

An investor who intends to give or take delivery would have to inform his broker
of the same prior to the start of delivery period.

Delivery is at the option of the seller; a buyer can take delivery only in case of a
willing seller. All unmatched/rejected/excess positions are cash settled; all open
positions for which no delivery information is submitted are also cash settled.
Under cash settlement, the difference between the contract price and settlement
price is to be paid or received.

How do they differ from equity futures?

Unlike the stock markets that close by 3-30 p.m., the NMCE is open till 8.00
p.m. and the MCX and the NCDEX until 11.00 p.m. However, only crude and
metals are traded in the night sessions. This enables the working public to place
orders from their homes.

Unlike equity futures, which have a life cycle of three months, contract duration
in case of commodity futures vary, and in some instances extends up to six
months.

Market participants can hedge their position over a longer period. Commodity
futures are also easier to understand compared to equity futures, as one has to
just keep track of demand and supply and not the several financial metrics that
the latter calls for.

Sales tax is applicable only when a contract results in delivery.

What margins are to be maintained?

Investors are required to maintain margins and top up their accounts on a daily
basis — marked-to-market margin — for fluctuations based on the tick size.
Margins have different components; there is an additional delivery margin that
has to be maintained once the contract enters the delivery period in case of
delivery settlements.

How to give delivery?

A seller intending to give delivery would have to approach the accredited

warehouse for availability of space and the assayer, who certifies the quality of
the goods; the goods are required to meet the pre-set quality specifications.

The seller has to bear storage charges until the date of demat credit,
loading/unloading and all other incidental charges, including assaying charges.

Not all goods can be delivered to all warehouses, as there are specific delivery
centres, which vary from commodity to commodity and from exchange to
exchange. However, the seller has the option of choosing the delivery centre
among these accredited warehouses.

How to take delivery?

A buyer intending to take physical delivery has to request his broker. The buyer
has to then approach the warehouse with the document (re-materialisation form
or the warehouse receipt).

It is possible to take partial delivery of the commodities from the warehouse. All
incidental charges pertaining to taking delivery are to be borne by the buyer.

Who regulates the commodity futures market?

Commodity futures and the relevant exchanges are regulated by the Central
Government under the Forward Contracts (Regulation) Act and the Forward
Contract Regulation Rules.

FMC, which functions under the Ministry of Consumer Affairs, Food & Public
Distribution, regulates the futures market in commodities.