Commodity Market in India

Joseph Anbarasu on 12 – 1 - 2011

Commodity market
A potato producer could purchase potato
futures on a commodity exchange to lock
in a price for a sale of a specified amount
of potato at a future date, while at the
same time a speculator could buy and sell
potato futures with the hope of profiting
from future changes in potato prices.
Model Process
Introduction
A revolution in Commodity derivatives and
risk management
Commodity options banned between 1952 and
2002
Commodity market began from 2003 onwards
Almost all stock exchanges have commodity
market segments apart from 3 national level
electronic exchanges
Almost Eighty commodities are in the list now
History
Cotton Trade Association started
futures trading in 1875
Derivatives trading started in
oilseeds in Bombay (1900), raw
jute and jute goods in Calcutta
(1912), wheat in Hapur (1913)
and in Bullion in Bombay (1920)
The Government of Bombay
prohibited options business in
cotton in 1939
In 1943, forward trading was
prohibited in oilseeds and some
other commodities including
food-grains, spices, vegetable
oils, sugar and cloth.
After Independence
The Parliament passed Forward Contracts (Regulation) Act,
1952
The Act envisages three-tier regulation:
◦ The Exchange which organizes forward trading in commodities can
regulate trading on a day-to-day basis;
◦ the Forward Markets Commission provides regulatory oversight
under the powers delegated to it by the central Government, and
◦ the Central Government - Department of Consumer Affairs, Ministry
of Consumer Affairs, Food and Public Distribution is the ultimate
regulatory authority.
In 1960s, following several years of severe draughts that
forced many farmers to default on forward contracts (and even
caused some suicides), forward trading was banned in many
commodities considered primary or essential.
Policy Shift – Kabra Committee
Government set up a
Committee in 1993 to examine
the role of futures trading. The
Kabra Committee
recommended allowing futures
trading in 17 commodity
groups.
It recommended certain
amendments to Forward
Contracts (Regulation) Act
1952, particularly allowing
options trading in goods and
registration of brokers with
Forward Markets Commission.
After Effect
The Government accepted
most of these
recommendations and futures
trading was permitted in all
recommended commodities.
Derivatives do perform a role
in risk management led the
government to change its
stance.
Liberalization facilitates
market forces to act freely
The next decade is being
touted as the decade of
commodities.
Why Derivatives?
The possibility of adverse
price changes in future
creates risk for businesses.
Derivatives are used to
reduce or eliminate price risk
arising from unforeseen price
changes.
A derivative is a financial
contract whose price depends
on, or is derived from, the
price of another asset.
Two important derivatives
are futures and options.
Commodity Futures Contracts
A futures contract is an
agreement for buying or
selling a commodity for a
predetermined delivery
price at a specific future
time.
They are Standardized
Contracts
Traded in Future Exchanges
(Default is taken care)
Chicago Board of Trade in
1848
Commodity Options contracts
Like futures, options are also
financial instruments used for
hedging and speculation.
The commodity option holder
has the right, but not the
obligation, to buy (or sell) a
specific quantity of a commodity
at a specified price on or before a
specified date.
Buyer and Selling.
Call Option and Put option
The option holder will exercise
the option only if it is beneficial
to him; otherwise he will let the
option lapse.
 Example
For example, suppose a farmer buys a put option to sell 100 Quintals of wheat
at a price of $25 per quintal and pays a ‘premium’ of $0.5 per quintal (or a total
of $50). If the price of wheat declines to say $20 before expiry, the farmer will
exercise his option and sell his wheat at the agreed price of $25 per quintal.
However, if the market price of wheat increases to say $30 per quintal, it would
be advantageous for the farmer to sell it directly in the open market at the spot
price, rather than exercise his option to sell at $25 per quintal.
Multi Commodity Exchange (MCX)
Multi Commodity Exchange (MCX) is an
independent commodity exchange based in
India.
◦ Established in 2003 and Based in Mumbai
◦ Turnover in 2009 was USD 1.24 trillion
◦ Sixth largest commodity exchange
◦ It was established in 2003 and is based in Mumbai.
MCX offers futures trading in
◦ bullion, ferrous and non-ferrous metals, energy, and a
number of agricultural commodities (menthol oil,
cardamom, potatoes, palm oil and others).
Organisation
MCX has also set up in joint
venture the MCX Stock
Exchange.
Earlier spin-offs from the
company include the National
Spot Exchange, an electronic
spot exchange for bullion and
agricultural commodities, and
National Bulk Handling
Corporation (NBHC) India's
largest collateral management
company which provides bulk
storage and handling of
agricultural products.
MCX Achievement
It is regulated by the Forward Markets Commission.
◦ MCX is India's No. 1 commodity exchange with 83% market share in
2009
◦ Competitor is National Commodity & Derivatives Exchange Ltd
◦ Globally, MCX ranks no. 1 in silver, no. 2 in natural gas, no. 3 in crude
oil and gold in futures trading
◦ The highest traded item is gold.
◦ MCX has several strategic alliances with leading exchanges across the
globe
◦ As of early 2010, the normal daily turnover of MCX was about US$ 6
to 8 billion
◦ MCX now reaches out to about 800 cities and towns in India with the
help of about 126,000 trading terminals
◦ MCX COMDEX is India's first and only composite commodity futures
price index
Key shareholders
Financial Technologies Corporation Bank,
(I) Ltd., Union Bank of India,
State Bank of India and Canara Bank,
its associates, Bank of India,
National Bank for Bank of Baroda ,
Agriculture and Rural HDFC Bank,
Development SBI Life Insurance Co.
(NABARD), Ltd.,
National Stock Exchange ICICI ventures,
of India Ltd. (NSE), IL & FS, Merrill Lynch, and
Fid Fund (Mauritius) Ltd. New York Stock Exchange
Unresolved Issues
Commodity Options
◦ Farmers not beneficiaries in price rise
The Warehousing and Standardization
◦ Physical Delivery needs backup
Cash Versus Physical Settlement
The Regulator
◦ week FMC
Lack of Economy of Scale
Tax and Legal bottlenecks
◦ Across States impossible
Thanks
Narender L. Ahuja for his article “Commodity
Derivatives Market in India: Development, Regulation and Future
Prospects” International Research Journal of Finance and Economics,
ISSN 1450-2887 Issue 2 (2006), Euro-Journals Publishing, Inc. 2006
http://www.eurojournals.com/finance.htm
Investopedia
MCX website
SEBI website