RECORD NOTEBOOK

FACULTY OF COMMERCE
DEPARTMENT OF COST & MANAGEMENT
ACCOUNTING (CMA)

B.COM (CMA) – COMMODITY MARKETING

OPERATION - HBCO18ML5

2021 –2022 (EVEN SEMESTER)

NAME : S.ASHFAQ

REGISTER NO. : 203221101005

COURSE : B.Com (CMA)

YEAR / SEM : II / IV
 BONAFIDE CERTIFICATE

Certified that this is a Bonafide Record of work done by S.ASHFAQ of(Reg. No.203221101005) B.Com
(CMA) II year in COMMODITY MARKETING OPERATION - HBCO18ML5 during the IV semester
in the year 2021-2022.

Submitted for the Practical Examination held on _____________

(Ms.N.M. Vaishnave) (Dr.A.Anuradha)

Signature of subject in charge Signature of
HOD

Examiner
PROJECT 1
 COMMODITY MARKETING OPERATIONS
INTRODUCTION

. A commodity market is a market that trades in the primary economic sector rather than
manufactured products, such as cocoa, fruit and sugar. Hard commodities are mined, such as
gold and oil.[1] Futures contracts are the oldest way of investing in commodities.[citation needed]
Commodity markets can include physical trading and derivatives trading using spot prices,
forwards, futures, and options on futures.[clarification needed] Farmers have used a simple form of
derivative trading in the commodity market for centuries for price risk management.

A commodity is a basic good used in commerce that is interchangeable with other goods of the
same type. Traditional examples of commodities include grains, gold, beef, oil, and natural gas.

For investors, commodities can be an important way to diversify their portfolios beyond
traditional securities. Because the prices of commodities tend to move in opposition to stocks,
some investors also rely on commodities during periods of market volatility.

A financial derivative is a financial instrument whose value is derived from a commodity termed
an underlier.[3] Derivatives are either exchange-traded or over-the-counter (OTC). An increasing
number of derivatives are traded via clearing houses some with central counterparty clearing,
which provide clearing and settlement services on a futures exchange, as well as off-exchange in
the OTC market

THE ORGIN OF COMMODITY MARKET

Commodity-based money and commodity markets in a crude early form are believed to have
originated in Sumer between 4500 BC and 4000 BC. Sumerians first used clay tokens sealed in a
clay vessel, then clay writing tablets to represent the amount—for example, the number of goats,
to be delivered.[9][10] These promises of time and date of delivery resemble futures contract.

Early civilizations variously used pigs, rare seashells, or other items as commodity money. Since
that time traders have sought ways to simplify and standardize trade contracts.[11][12]
Gold and silver markets evolved in classical civilizations. At first, the precious metals were
valued for their beauty and intrinsic worth and were associated with royalty.[11] In time, they were
used for trading and were exchanged for other goods and commodities, or for payments of labor.
[13]
Gold, measured out, then became money. Gold's scarcity, its unique density and the way it
could be easily melted, shaped, and measured made it a natural trading asset.[14]

THE ORGIN OF COMMODITY MARKET IN INDIA

The history of organized commodity derivatives in India goes back to the nineteenth century
when Cotton Trade Association started futures trading in 1875, about a decade after they started
in Chicago. Over the time datives market developed in several commodities in India. Following
Cotton, derivatives trading started in oilseed in Bombay (1900), raw jute and jute goods in
Calcutta (1912), Wheat in Hapur (1913) and Bullion in Bombay (1920).

However many feared that derivatives fuelled unnecessary speculation and were detrimental to
the healthy functioning of the market for the underlying commodities, resulting in to banning of
commodity options trading and cash settlement of commodities futures after independence in
1952.

The parliament passed the Forward Contracts (Regulation) Act, 1952, which regulated contracts
in Commodities all over the India. The act prohibited options trading in Goods along with cash
settlement of forward trades, rendering a crushing blow to the commodity derivatives market.
Under the act only those associations/exchanges, which are granted reorganization from the
Government, are allowed to organize forward trading in regulated commodities. The act
envisages three tire regulations: (i) Exchange which organizes forward trading in commodities
can regulate trading on day-to-day basis; (ii) Forward Markets Commission provides regulatory
oversight under the powers delegated to it by the central Government. (iii) The Central
Government- Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public
Distribution- is the ultimate regulatory authority.

The commodities future market remained dismantled and remained dormant for about four
decades until the new millennium when the Government, in a complete change in a policy,
started actively encouraging commodity market. After Liberalization and Globalization in 1990,
the Government set up a committee (1993) to examine the role of futures trading. The
Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in 17
commodity groups. It also recommended strengthening Forward Markets Commission, and
certain amendments to Forward Contracts (Regulation) Act 1952, particularly allowing option
trading in goods and registration of brokers with Forward Markets Commission

The Government accepted most of these recommendations and futures’ trading was permitted in
all recommended commodities. It is timely decision since internationally the commodity cycle is
on upswing and the next decade being touched as the decade of Commodities. Commodity
exchange in India plays an important role where the prices of any commodity are not fixed, in an
organized way. Earlier only the buyer of produce and its seller in the market judged upon the
prices. Others never had a say.

Today, commodity exchanges are purely speculative in nature. Before discovering the price, they
reach to the producers, end-users, and even the retail investors, at a grassroots level. It brings a
price transparency and risk management in the vital market. A big difference between a typical
auction, where a single auctioneer announces the bids and the Exchange is that people are not
only competing to buy but also to sell. By Exchange rules and by law, no one can bid under a
higher bid, and no one can offer to sell higher than someone else’s lower offer. That keeps the
market as efficient as possible, and keeps the traders on their toes to make sure no one gets the
purchase or sale before they do.

Since 2002, the commodities future market in India has experienced an unexpected boom in
terms of modern exchanges, number of commodities allowed for derivatives trading as well as
the value of futures trading in commodities, which crossed $ 1 trillion mark in 2006. Since 1952
till 2002 commodity datives market was virtually non- existent, except some negligible activities
on OTC basis.

In 2002-03, Prime Minister, Shri. A. B. Vajpayee, in his Independence Day address to the nation
on 15th August 2002, demonstrated its commitment to revive the Indian agriculture sector and
commodity futures markets. The GOI in that very year took two steps that gave a fillip to the
commodity markets. The first one was setting up of nation wide multi commodity exchanges and
the second one was expansion of list of commodities permitted for trading under (FC(R) A).

In India there are 25 recognized future exchanges, of which there are three national level multi-
commodity exchanges. After a gap of almost three decades, Government of India has allowed
forward transactions in commodities through Online Commodity Exchanges, a modification of
traditional business known as Adhat and Vayda Vyapar to facilitate better risk coverage and
delivery of commodities. The three exchanges are: National Commodity & Derivatives
Exchange Limited (NCDEX) Mumbai, Multi Commodity Exchange of India Limited (MCX)
Mumbai and National Multi-Commodity Exchange of India Limited (NMCEIL) Ahmedabad.
There are other regional commodity exchanges situated in different parts of India

Types of commodities traded in India

Bullion: Gold, Silver

Base Metals: Aluminum, Brass, Copper, Lead, Nickel, Zinc

Energy: Crude oil, Natural gas

Agri commodities:Black pepper, Cardamom, Castor seed, Cotton, Crude palm oil, Mentha oil,
Palmolein, Rubber

Major Commodity Exchanges in India:

Multi Commodity Exchange (MCX)

Multi Commodity Exchange (MCX) is an exchange where commodities like crude oil, lead,
gold, etc are traded

Multi Commodity Exchange of India Ltd (MCX) (BSE: 534091) is a commodity exchangebased

in India. It is under the ownership of Ministry of Finance , Government of India. It was
established in 2003 by the Government of India and is currently based in Mumbai . It is India's
largest commodity derivatives exchange.

The average daily turnover of commodity futures contracts increased by 26% to ₹32,424
crore during FY2019-20, as against ₹25,648 crore in FY2018-19. The total turnover of
commodity futures traded on the Exchange stood at ₹83.98 lakh crore in FY2019-20. MCX
offers options trading in gold and futures trading in non-ferrous metals, bullion, energy, and a
number of agricultural commodities (mentha oil, cardamom, crude palm oil, cotton, and
others).

National Commodity and Derivatives Exchange:

The National Commodity & Derivatives Exchange (NCDEX) is a commodities exchange
dealing primarily in agricultural commodities in India. The National Commodity & Derivatives
Exchange was established in 2003, and its headquarters are in Mumbai.1

Many of India's leading financial institutions have a stake in the NCDEX. As of 2021, significant
shareholders included Life Insurance Corporation of India (LIC), the National Stock Exchange
of India Limited (NSE), and the National Bank for Agricultural and Rural Development
(NABARD).2

Indian Commodity Exchange

Indian Commodity Exchange Limited or ICEX is a SEBI regulated online Commodity

Derivative Exchange, headquartered at Mumbai. 

ICEX provides a nationwide trading platform through its appointed brokers for commodity
trading in India. 

ICEX launched the world’s first-ever Diamond derivatives contract of 1 carat in August 2018.

-*+The Indian Commodity Exchange Limited (ICEX) started its operation in August 2017. After
a year, on August 28 2018, the exchange launched its steel long contract.

In 2018-2019, the National Company Law Tribunal (NCLT) sanctioned the amalgamation of the
NMCE with ICEX. (National Multi Commodity Exchange of India Limited with Indian
Commodity Exchange Limited)

On 11th July 2019, ICEX launched ‘Paddy Basmati’ Derivatives Contract.

ICEX helps farmers in key aspects like price discovery, risk management. Also,  allows them to
trade in derivative contracts which are not available in MCX.

PRODUCTS TRADED IN INDIA

On the exchanges, you can trade in hard as well as soft commodities. Hard commodities include
crude oil, metals, etc. and soft commodities generally have a shelf life and include agricultural
commodities like wheat, soybean, corn, cotton, etc.

Globally, the most-traded commodities include gold, silver, crude oil, Brent oil, natural gas,
soybean, cotton, wheat, corn, and coffee. Here is some insight into a few of these commodities

1. Crude oil

Crude oil is one of the most sought-after commodities. With several byproducts such as
petroleum and diesel, the demand for crude oil is increasing every day, especially due to the
boom in demand for automobiles. The high demand has even led to the eruption of geopolitical
tensions all over the world. OPEC is a consortium of the nations that produce oil, and some of
the top oil-producing countries are Saudi Arabia, USA and Russia.

2. Gold

Gold has always been an anchor for most people. When we see the price value of the US dollar
fall, we start buying more gold for security and when the price value of the dollar goes up, gold
prices tend to fall; they share an inverse relationship.

3. Soybeans

Soybean is also one of the top commodities, but is often impacted by factors like weather,
demand for dollars and demand for biodiesel.

Types of commodities traded in India (National Commodity

and Derivatives Exchange – NCDEX):
 Cereals and pulses: Maize Kharif/south, Maize rabi, Barley, Wheat, Chana, Moong,
Paddy (basmati)
 Soft: Sugar
 Fibres: Kappa’s, Cotton, Guar seed, Guar gum
 Spices: Pepper, Jeera, Turmeric, Coriander
 Oil and Oil seeds: Castor seed, Soybean, Mustard seed, Cotton seed oil cake, Refined
soy oil, Crude palm oil

Participants of commodity market:

Two kinds of traders enter in the commodity market. They vary from each other on the basis of
the positions they take up in the market.
The psychology of both these segments varies a lot, and their actions affect the overall market
situations. These groups are:

Speculators:

Speculators and hedgers are the drivers of commodity market. These traders constantly analyze
the prices of commodities and forecast the future price movement. For example, if they predict
the prices to move higher, they buy commodity futures contract and if the prices seem to move
higher, they sell the contracts at a price higher than the price at which they bought. If they feel
that the prices would move down, they sell the contracts and then buy them again at an even
lower price. In both the cases, they tend to make profits.

Hedgers:

Producers, manufacturers, etc. usually hedge their risk by using commodity futures market. Let
us take an example to understand this concept. There is a wheat farmer and if there is fluctuation
of prices during harvest and if price falls, farmer would face loss. To hedge this risk, the farmer
enters into a futures contract. When there is fall in price in the local market, the farmer can
compensate this loss by making gains in the futures market. In case there is increase in price
during harvest, the farmer would face loss in the futures market but he can compensate this loss
by selling it at a higher price in the local market.

FUNCTIONS OF COMMODITY MARKET IN INDIA:

Looking at its significance, it is easy to say that the function of commodity markets in India is
pivotal to protecting citizens and the growth of the economy. Here are some of the ways the
market plays its role.

Bigger Investment In The Agricultural Ecosystem

Today, one of the biggest challenges in the agriculture sector is the absence of a well-designed
post-harvest system which leads to a substantial loss of food grains during the transmission,
affecting the prices and putting the farmers at a loss.

A regulated commodity market serves as a rescue for farmers, brokers, consumers, and investors.
Such a mechanism also encourages bigger investments in agriculture in improved transport
facilities and warehousing systems. This will, in turn, result in a better-developed ecosystem.

Achieving Food Security

The Indian government achieves food security through commodity markets. Recent reports show
how grains are worth more than Rs.800 crores were destroyed in Punjab because of poor
warehousing.

Farmers in India face such a problem and are forced to risk the food they produce on farms.
However, they can use the futures market to sell their grains by locking in a price to ensure the
fluctuations don’t affect their situation.

Oversupply of a commodity in the market weakens the prices, which can be dealt with by selling
futures on the commodity at a price that profits the farmers. Farmers living in Western countries
generally use the futures market to hedge the price shifts for agricultural products.

Aggregation and Financing Mechanism

One of the biggest problems Indian farmers face is that they are small and dispersed. An
aggregator is the only saviour in this scenario. At this time, the role of the aggregator is played
by middlemen, but it does not ensure the transparency of the system.

A well-organized commodity market can prove to be an effective aggregator as it provides a

guaranteed aggregation system that facilitates dispersed farmers. Financing is another significant
aspect of commodity markets.

These markets enable raising finances against warehouse receipts and rid the agriculture sector
of relying on unorganized financing.

New Asset Class For Retail Investors

The investment options for Indian traders have always remained limited to real estate, gold,
equities, bonds, and FDs. Though investors can indirectly invest in commodities through equity
markets, commodities were not available as an asset class for direct investment.

The commodity market allows investors, small and big, to diversify their portfolios and lower the
risk of other investments. Traders can find a wide variety of commodities to put their money
into.

Getting started with commodities investment India can seem daunting at first, but there is a
strong ecosystem surrounding this market, focused on education and advisory services,
increasing the reach and traction of the overall market.
PROJECT 2
Abstract
Commodity markets have been gaining importance in recent years, giving participants
an opportunity to go for forward contracting and hedging. In particular, derivative
markets have attained more than eighteen times in trading volume when compared to
the spot markets. This paper provides an overview of the commodity market in India
and its participants, and analyses twelve commodities that are traded in MCX (Multi
Commodity Exchange), in terms of price discovery of the spot and futures markets
using GARCH model. It also analyses the impact of trading volume, inflation and other
macroeconomic factors on spot and futures price movements. Keywords: Commodities,

Exchange,Futures Market, Derivatives, Commodity derivative market

INTRODUCTION:
Commodity markets cover physical assets such as precious metals, base metals, energy
(oil, electricity), food (wheat, cotton, pork bellies), and weather. The commodities
market, in India was for the most part underdeveloped in the years prior to 1990’s. The
Essential Commodities Act (ECA) of 1955 and the Forward Contracts (Regulation) Act
(FCRA) 1952 restricted the trade in commodities, futures contracts and forward
contractsto only certain items. Most of the trading is done using futures (total trading
volume around 200billion dollars for the year 2002).The economic reforms of 1991
paved the way for the formulation of an expert committee headed by Prof. K. N Kabra;
to deal with the development of the sector.

The committee gave its report in the June of 1993. This led to the reintroduction of
futures which were earlier banned in the year 1966. Agricultural commodities in
addition to silver were permitted underthe commodities trade. With the introduction of
the National Agricultural policy of 2000, there were substantial reforms in the domestic
and external commodities market reforms that led to the elimination of all kinds of
unnecessary controls and regulations in the agricultural commoditiesmarket. several
centers at Punjab and U.P. The most notable amongst them was the Chamber of
Commerce at Hapur, which was established in 1913. Futures market in Bullion began at
Mumbai in 1920 and later similar markets came up at Rajkot, Jaipur, Jamnagar, Kanpur,
Delhi, and Calcutta

EVOLUTION OF COMMODITY DERIVATIVES TRADING

IN
INDIA

Organized trading in commodity derivatives was initiated in India with the set up of
Bombay
Cotton Trade Association Ltd in 1875. Following this, Gujarati Vyapari Mandali was
set up in
1900 to carryout futures trading in groundnut, castor seed and cotton. Forward trading
in Raw
Jute and Jute Goods began in Calcutta with the establishment of the Calcutta Hessian
Exchange Ltd., in 1919. Later East Indian Jute Association Ltd. was set up in 1927 for
organizing futures trading in Raw Jute. These two associations amalgamated in 1945 to
form the present East India Jute & Hessian Ltd., to conduct organized trading in both
Raw Jute and Jute goods. In case of wheat, futures markets were in existence at
exchange in the country. MCX started its operations on November 10, 2003 and today it
holds a market share of over 80 per cent of the Indian commodity futures market and
has more than 2000 registered members operating through over 100,000 trader work
stations across India. The exchange has also emerged as the sixth largest and amongst
the fastest 6growing commodity futures exchange in the world, in terms of the number
of contracts traded in 2009. MCX offers more than 40 commodities across various
segments such as bullion, ferrous and non-ferrous metals, and a number of agri-
commodities on its platform. The Exchange is the world’s largest exchange in silver,
the second largest in gold, copper and natural gas and the third largest in crude oil
futures, with respect to the number of futures contracts traded. MCX maintains an
Insured Settlement Guarantee Fund of about Rs. 100 crores. Even as reform initiatives
are slowly taking shape, turnover in the Indian commodity futures market has increased
many times over. The total value of trade in the Commodity Futures Market has risen
substantially in the last few years .

Production: Estimated output based on the acreage and weather conditions and pest
infestation etc., Imports and exports: In case of the commodities that have a sizeable
amount of external trade (either imports or exports) such as edible oils and pulses, the
traders need to know the details of important sources and destinations of the external
trade. Further, the traders have to monitor the crop status in the respective countries.
Government policies: any change in government policy relating to the crops.
Procurement: direct procurement by the government agencies and storage in
warehouses change in tariff and base prices of externally traded goods will have a direct
impact on the respective commodity prices.

The Forward Markets Commission (FMC) is the regulatory body for the commodity
market and futures market in India. It is a division of the Securities and Exchange
Board of India, Ministry of Finance, Government of India. As of July 2014, it regulated
Rs 17 trillion[1] worth of commodity trades in India. It is headquartered in Mumbai and
this financial regulatory agency is overseen by the Ministry of Finance. The
Commission allows commodity trading in 22 exchanges in India, of which 6 are
national.

On 28 September 2015 the FMC was merged with the Securities and Exchange Board
of
India (SEBI) to make the regulation of commodity futures market strong

Established in 1953 under the provisions of the Forward Contracts (Regulation) Act, 1952, it consists
of not less than two but not exceeding four members appointed by the central government, out of
them one being nominated by the central government to be the chairman of the commission.

Since futures traded in India are traditionally on food commodities, the agency was originally
overseen by Ministry of Consumer Affairs, Food and Public Distribution (India).[4]

The commission appeared in the news in March 2012 for their ban on guar gum futures trading after
it said the price quadrupled due to its use in fracking causing food inflation.[5]
In September 2013, the commission responsibility was moved to the Ministry of Finance to reflect
that futures trading was becoming more and more a financial activity.

The functions of the Forward Markets Commission are as

follows:

• To advise the central government in respect of the recognition or the withdrawal of

recognition from any association or in respect of any other matter arising out of the
administration of the Forward Contracts (Regulation) Act 1952.
• To keep forward markets under observation and to take such action in relation to
them, as it may consider necessary, in exercise of the powers assigned to it by or
under the Act.
• To collect and whenever the Commission thinks it necessary, to publish information
regarding the trading conditions in respect of goods to which any of the provisions
of the act is made applicable, including information regarding supply, demand and
prices, and to submit to the central government, periodical reports on the working of
forward markets relating to such goods;
• To make recommendations generally with a view to improving the organization and
working of forward markets;
• To undertake the inspection of the accounts and other documents of any recognized
association or registered association or any member of such association whenever it
considers it necessary.

It allows futures trading in 23 fibers and manufacturers, 15 spices, 44 edible oils, 6

pulses, 4 energy products, single vegetable, 20 metal futures and 33 other futures.

STRUCTURE OF COMMODITY EXCHANGE

THE COMMODITIES MARKET EXISTS IN TWO DISTINCT FORMS:

• over-the-counter (OTC) market

• exchange based market

Similar to equities, there exists the spot and the derivatives segments. Spot markets are
essentially OTC markets and participation is restricted to people who are involved with
that commodity, such as the farmer, processor, wholesaler, etc.
A majority of the derivatives trading takes place through the exchange-based markets
with standardized contracts, settlements, etc. The exchange-based markets are
essentially derivative markets and are similar to equity derivatives in their working, that
is, everything is standardized and a person can purchase a contract by paying only a
percentage of the contract value.

A person can also go short on these exchanges. Moreover, even though there is a
provision for delivery, most contracts are squared-off before expiry and are settled in
cash. As a result, one can see an active participation by people who are not associated
with the commodity. The typical structure of commodity futures markets in India is as
follows

Ministry of Consumer Affairs, Food, and Public Distribution

The Department pertaining to consumer affairs is responsible for the formulation of

policies for:

• Monitoring Prices
• Consumer Movement in the country
• Controlling of statutory bodies (Bureau of Indian Standards (BIS) and Weights
and Measures)
 • Internal Trade
• Inter-State Trade- The Spirituous Preparations (Inter-State Trade and
Commerce) Control Act, 1955 (39 of 1955).
• Control of Futures Trading- the Forward Contracts (Regulations) Act, 1952 (74
of 1952)

The Department for food and public distribution is responsible for the formulation of
policies for:

• Ensuring food security for the country through timely and efficient procurement
and distribution of food grains.
• Building up and maintenance of food stocks, their storage, movement and
delivery to the distributing agencies and monitoring of production, stock and
price levels of food grains.

• Incentivizing farmers through fair value of their produce by way of Minimum

Support Price mechanism, distribution of food grains to Below Poverty Line
(BPL) families.
• Covering poor households at the risk of hunger under Antyodaya Anna Yojna
(AAY).
• Establishing grain banks in food scarce areas and involvement of Panchayati Raj
Institutions in Public Distribution System (PDS).
• Concerns for the sugar sector such as fixing of Fair and Remunerative Price
(FRP) of sugarcane payable by Sugar factories, development and regulation of
sugar industry (including training in sugar technology), fixation of levy price of
sugar and its supply for PDS and regulation of supply of free sale sugar.
• Export and import of food grains, sugar and edible oils.
•
I) Types Of Membership

• Trading Cum Clearing Member (TCM) & Self Clearing Member (SCM)
• Trading Member (TM)

A) Trading Cum Clearing Member (TCM) / Trading cum Self Clearing Member (SCM)

• Who can become a member of the Commodity Derivatives segment as a TCM / SCM?
Any Individual/Corporate/Partnership Firm/LLP can become a TCM / SCM subject to the networth criteria as
prescribed by SEBI being fulfilled.

• What are the criteria of becoming a TCM / SCM of the Exchange?

 * Networth Rs.3 crores for TCM (as prescribed by SEBI) and

Rs.1 crore for SCM (as prescribed by SEBI)

Top

A) Trading Member

• Who can become a trading member in the Commodity Derivatives segment?

Any Individual/Corporate/Partnership Firm/LLP can become a Trading Member subject to the networth
criteria as prescribed by SEBI being fulfilled.

• What is the criteria of become a Trading Member in the Commodity Derivative segment of the Exchange?

Rs.25
lakhs for
* Networth Corporat
es

Rs.10
lakhs for
Non-
Corporat
es
* Minimum security Deposit NIL

Top

II) Commodity Derivatives segment deposit and fee

structure:
S Deposit / Fees Deposit /
r Fees Amount
1 Membership Deposit NIL
 2 50,000/-
plus GST**

Admission Fees

3 Processing Fees NIL

4 Annual Subscription Fees Rs.1,00,000/

- plus
GST**

COMMODITY RISK MANAGEMENT STRATEGIES FOR

PRODUCERS

Strategic Risk Management

#1 – Diversification:

In the case of diversification, the producer generally rotates his production (Either
rotation through different products or rotation of production facility of the same
product) to manage the price risk or cost risk associated with production. While
adopting diversification, producers should ensure that alternative products should not
subject to the same price risk.

Diversification example: In the case of a farm business, rotation of crops to produce

different products can greatly reduce the large loss from price volatility.

While adopting the diversification, producers may incur high costs in the form of
reduced efficiencies and lost economies of scale while resources are diverted to a
different operation. #2 – Flexibility:

It is a part of a diversification strategy. A flexible business is one that has the ability to
change in line with market conditions or events that may have an adverse impact on
business.

Flexibility Example: A steel company in falling prices scenario may instead of

producing steel using coal use low-cost pulverized coal, which has the same effect at a
lower cost. This flexibility has an effect of improving financial performance.
Price Risk Management
#1 – Price pooling arrangement: In this commodity is collectively sold to a
cooperative or marketing board, which sets the price of the commodity-based on a
number of factors that result in an average price for all those within the group.

#2 – Storing: In times where there is an increased production, which resulted in

reduced selling price, some producers may store the production till a favorable price is
obtained. However, when considering this, storage cost, interest cost, insurance, and
spoilage costs need to be considered. #3 – Production contracts: In the case of
production contracts, the producer and buyer enter a contract, usually covering price,
quality, and quantity supplied. In this case, the buyer typically retains ownership over
the production process(This is most prevalent in the case of live stocks).

Commodity Risk Management Strategies for Buyers

The following are the most common methods of managing commodity price risk for the
business of purchasing commodities.

#1 – Supplier Negotiation: This buyer approaches suppliers for an alternative pricing

plan. They may lower prices on increased volume purchases or offer alternatives or may
suggest a change to the supply chain process

#2 – Alternative sourcing: In this buyer, appoint an alternative producer for getting the
same product or approach a different producer for substitute products in the
production process. Companies generally have strategies in place to review the use of
commodities within the business is risk compliant.
#3 – Production process review: In this company usually review the use of
commodities in the production process regularly with a view to change the mix of
products to offset commodity price increases.

Example: Manufacturers of food products continuously look for improvements in a

product using less of higher-priced or more volatile inputs such as sugar or wheat.
Now that we understand how to manage the commodity risks from the producer and
Buyer perspective let us go ahead to see what are the various financial market
instruments to manage the commodity risks.

CLEARING AND SETTLEMENT ON COMMODITY

EXCHANGE
1. Clearing & Settlement is a system whereby Exchange guarantees the
settlement of the trade on its platform.
2. 2.  Commodity markets are markets where raw or primary products are
exchanged.  These raw commodities are traded on regulated commodities
exchanges, in which they are bought and sold
3. 3. RISK IN COMMODITY MARKET Refers to the uncertainties of future
market values and of the size of the future income, caused by the fluctuation in
the prices of commodities Commodity future contracts are standardised in terms
of quality of the underlying commodity LIQUIDITY: given that the features of
futures contracts are standardised by the exchange allowing them to trade on the
exchange, the contracts are liquid and there is always a ready market for them.
Absence of counter party risk: PRICE DISCOVERY: the electronic trading
platform provided by the commodity exchange combined with liquidity and risk
free trading encourages wider participation, ensuring larger volumes and
minimised price manipulation.
4. 4.  Market risk- Risk of loss suffered by buyers or sellers on account of
adverse event of prices  Credit risk-It is very low or almost zero because the
exchange takes on the responsibility for the performance  Operational risk
arising out of some operational difficulties  Legal risk is risk coming from
legal objections that might be raised since the exchange regulatory framework
might disallow some activities
5. 5. COMMODITY CLEARING HOUSE  Clearing house can be defined as
entity which is different from the exchange,  The clearing house is responsible
for keeping records
6. 6. Clearing house  Clearing house acts as a seller to all buyers and a buyer to
all sellers.   Each day of trading all exchange members must report their
buys and sell to the clearing house.  The clearing house then ensures that
financial settlement from all buyers and sellers is made to the clearing house. 
The clearing house guarantees all contracts by requiring that the participants
maintain cash deposits called margins or margins money.  As soon as a
contract is processed by the clearing house the buyer and seller of the contract
will have a contract with the clearing house instead of counter party with their
original trade
7. 7. Margining method  Margin money- Margin money is like a security deposit
or insurance against possible future loss of value.  The aim of margin money
like good faith money is to minimise the risk  To safeguard the integrity of the
market and its own interest, the exchange imposes the margin money  New
contracts on the first day are assigned on base rate  Settlement price based on
average of the last trades of the trading day  Due date rate calculated based on
average of the last few days closing prices
8. 8.  Initial margin initial margin is the amount to be deposited by the market
participants in their margin account with the clearing house before they can
place buy or sell order of a futures contract.  VARIATION OR MARK TO
MARKET MARGIN:  Margin is worked out on the difference between the
closing rate and rate of the contract  It helps to protect the interest of the
exchange
9. 9.  Additional (volatility) margin:  Volatility margin is extra margin imposed
by exchange on the buyer and the seller in the event of sudden increase in
volatility of prices of the underlying in the market.  Tender period margin: 
Extra margin imposed on the contracts during concluding phase  Maintenance
margin It is the minimum amount of margin that is required to be held in the
margin account relative to the futures position held
10. 10. OTHER RISK CONTAINMENT MEASURES USED BY EXCHANGES 
 Guarantee for Settlements  The exchange only ensures proper correlation
between prices in the spot and futures markets and guarantees the performance
of the contracts by analysing the risks on continuous basis.  The Settlement
Guarantee Fund (SGF), also called the Trade Guarantee Fund (TGF) 
Objective of the funds are  To guarantee settlement of bonafide transactions 
To inculcate confidence in the minds of market participants  To protect the
interest of investors
11. 11. Price limit and circuit breakers  procedures to control overreactions in
times of serious market volatility these mechanisms are known as circuit
breakers and price limits.  Price limit affect the way trading in the future
market  And circuit breaker deals with whether trading will be halted
temporarily, or stopped together entirely
12. 12.  Settlement process Physical delivery Cash settlement Based on the
underlying spot price
13. 13. TYPES OF SETTLEMENT
14. 14. WAREHOUSING AND WAREHOUSE RECEIPTS  Warehousing
provides
critical logistic support to the commodity sector  If the trade is expected to be
settled by way of delivery of the commodity the clearing house of the
commodity exchange  warehouse receipts from the seller instead of actual
commodities and pass such warehouse receipts over to the buyer.
15. 15. Warehouse receipts (WRs) are title documents issued by warehouse to
depositors against the commodities deposited in the warehouse  The
Warehousing (Development and Regulation) Act 2007  Negotiable warehouse
receipts (NWRS)  this help the farmers to avoid the distress sale of their
produce by ensuring them access to finance against their produced stored
16. 16. Dematerialisation of warehouse receipts  Act prescribes the form and the
manner of registration of warehouse and issue of NWRs in electronic form 
Disadvantages of physical warehouse receipts:  1. Need for splitting the
warehouse receipts in case the depositor has an obligation to transfer only a part
of the commodity  2.Need to move the warehouse receipt from one place to
another with risk of theft, mutilation etc.  3. Risk of forgery

THE END
 PROJECT 3

INTRODUCTION

COMMODITY MARKETING OPERATIONS

INTRODUCTION

. A commodity market is a market that trades in the primary economic sector rather than
manufactured products, such as cocoa, fruit and sugar. Hard commodities are mined, such as
gold and oil.[1] Futures contracts are the oldest way of investing in commodities.[citation needed]
Commodity markets can include physical trading and derivatives trading using spot prices,
forwards, futures, and options on futures.[clarification needed] Farmers have used a simple form of
derivative trading in the commodity market for centuries for price risk management.

A commodity is a basic good used in commerce that is interchangeable with other goods of the
same type. Traditional examples of commodities include grains, gold, beef, oil, and natural gas.

For investors, commodities can be an important way to diversify their portfolios beyond
traditional securities. Because the prices of commodities tend to move in opposition to stocks,
some investors also rely on commodities during periods of market volatility.

A financial derivative is a financial instrument whose value is derived from a commodity termed
an underlier.[3] Derivatives are either exchange-traded or over-the-counter (OTC). An increasing
number of derivatives are traded via clearing houses some with central counterparty clearing,
which provide clearing and settlement services on a futures exchange, as well as off-exchange in
the OTC market.
Multi Commodity Exchange of India Ltd (MCX)

Multi Commodity Exchange of India Ltd (MCX) (BSE: 534091) is a commodity exchange
based in India. It is under the ownership of Ministry of Finance , Government of India. It was
established in 2003 by the Government of India and is currently based in Mumbai . It is India's
largest commodity derivatives exchange. The average daily turnover of commodity futures
contracts increased by 26% to ₹32,424 crore during FY2019-20, as against ₹25,648 crore in
FY2018-19. The total turnover of commodity futures traded on the
Exchange stood at ₹83.98 lakh crore in FY2019-20. MCX offers options trading in gold and
futures trading in non-ferrous metals, bullion, energy, and a number of agricultural commodities
(mentha oil, cardamom, crude palm oil, cotton, and others).

MCX was among the top global commodity exchanges in terms of the number of futures
contracts trade, the latest yearly data from Futures Industry Association (FIA) showed. MCX
launched the MCX India Commodity Indices (MCX iCOMDEX) series on December 20,
2019, which conform to the global best practices set by the International Organisation of
Securities Commissions (IOSCO). iCOMDEX series consists of iCOMDEX Composite,
iCOMDEX Base Metals, iCOMDEX Bullion, iCOMDEX Gold, iCOMDEX Copper and
iCOMDEX Crude Oil. Subsequently, MCX received regulatory approval for launch of
futures contracts on MCX iCOMDEX Bullion and Base Metal indices. The exchange also set
up a web-based application "ComRIS" (Commodity Receipts Information System) in order to
maintain an electronic record of commodities deposited at the Exchange accredited warehouses
and ensure flow of real time information from the warehouses.
SEBI issued operational guidelines for participation of Mutual Funds and Portfolio Managers in
commodity derivatives in May 2019 and subsequently, approved few custodial service
providers as custodians in the commodity space.

In February 2012, MCX had come out with a public issue of 6,427,378 Equity Shares of Rs.

10 face value in the price band of Rs. 860 to Rs. 1032 per equity share to raise around $134

million. [clarify] It was the first-ever IPO by an Indian exchange and made MCX India’s only

publicly listed exchange.

From 28 September 2015, MCX is being regulated by the Securities and Exchange Board of
India (SEBI). Earlier MCX was regulated by the Forward Markets Commission (FMC), which
got merged with the SEBI on 28 September 2015.

Mr Padala Subbi Reddy (Mr P S Reddy) was appointed as MD & CEO of the Company for a
period of five w.e.f. May 10, 2019. Prior to this Mr Reddy worked as managing director and
CEO of Central Depository Services (CDSL).[1]

Commodities traded include -

Metal - Aluminium, Copper, Lead, Nickel, Zinc

Bullion - Gold, Gold Mini, Gold Guinea, Gold Petal, Gold Petal ( New Delhi), Gold Global,
Silver, Silver Mini, Silver Micro, Silver 1000.

Agro Commodities - Cardamom, Cotton, Crude Palm Oil, Kapas, Mentha Oil, Castor seed, RBD
Palmolien, Black Pepper.

Energy - Crude Oil, Natural Gas.

The efforts that started in the fourth quarter of FY 2018-19 to migrate to 'Compulsory Delivery-
based' contracts in all base metals were successfully completed in FY 2019-20. The launch of
indigenously benchmarked deliverable futures contracts of Copper, Aluminium, Zinc, Lead and
Nickel on MCX, has paved the way for the Indian market prices for metals to be discovered on
an exchange platform in a transparent manner. This fulfills an important step towards
development of domestic benchmarks which reflect domestic market fundamentals, while the
delivery standards are in tune with international standards.

Paving the way for introduction of Options with 'commodities' as underlying, the Government
of India issued a notification on October 18, 2019, which widens the scope of commodity
derivatives traded in recognised exchanges. Following this, SEBI permitted stock exchanges to
launch 'Option in goods' in their commodity derivatives segment, in addition to existing 'options
on commodity futures'. MCX has launched Gold Mini Options with Gold Mini (100 grams) bar
as the underlying, and plans to launch Silver Mini 5 Kg 'option in goods' contract soon.

OBJECTIVES
• a) to protect and safeguard the interest of investors/clients, in respect of
eligible/legitimate claims arising out of the default of the member of the Exchange;
• b) to impart investor/client education, awareness, research or such other programmes as
may be decided by the SEBI and/ or the Exchange from time to time out of the interest
earned on investments of the Fund; and
• c) to provide monetary relief to investor during the course of pendency of proceedings,
as per the guidelines / circulars issued by SEBI from time to time;
• d) to undertake such other activity which is ancillary to and in furtherance to the
aforesaid objects of the Trust;
• e) to do such other lawful acts, deeds, things as are incidental, conductive and necessary
for the attainment of the aforesaid objects but subject to the guidelines/directions issued
by SEBI from time to time.
ORGIN OF MCX-SX
MCX-SX, which currently offers currency derivatives trading, is the most recent entrant to
India's expanding landscape of public-trading exchanges as stocks and derivatives become
increasingly popular and widespread there. MCX-SX began trading currency derivatives on
October 7, 2008. Trading volume at MCX-SX grew rapidly and overtook those at a
longerestablished rival in the rapidly growing Indian currency futures market, which began
trading only in August 2008.
In July of 2012, the Securities and Exchange Board of India permitted MCX-SX to offer trading
in stocks and other asset classes. [1] The regulator had previously rejected MCX-SX's
application to open stock and debt trading platforms on top of its currency platform, saying the
application from MCX-SX had violated ownership limits restricting
individual shareholders in a stock market to 5 per cent and that the exchange had been
“dishonest” in its dealings with the regulator.[2]
MCX-SX launched a capital markets segment, futures and options segment and the flagship
index ‘SX40’ on February 9, 2013 and commenced trading on February 11, 2013. ‘SX40’, is a
free-float based index consisting of 40 large-cap, liquid stocks representing diverse sectors of
the economy. Trading in derivatives on the ‘SX40’ index began May 15, 2013. [3] In September
2014 the exchange received approval from the regulator SEBI to change its name and operate
under the new name, ‘Metropolitan Stock Exchange of India Ltd’, abbreviated as ‘mSXI’. The
exchange is in the process of registering for the new name. It also recently shifted its office to
new premises in Bandra Kurla Complex and moved its data center to Tata Communications in
BKC, Mumbai. [4]

Advantages of MCX
There are two significant advantages in MCX, and they are:

• Organised Structure
The price and changes of trading volumes are in an organized structure and
totally transparent in Margin Commodity of India (MCX). This helps all the
traders to make an informed choice.

• Wide Range of Opportunities

MCX provides a wide range of opportunities in the form of monthly contracts
of options and derivatives that offers much-needed liquidity and
diversification
National Commodity and Derivatives Exchange:

The National Commodity & Derivatives Exchange (NCDEX) is a commodities exchange

dealing primarily in agricultural commodities in India. The National Commodity & Derivatives
Exchange was established in 2003, and its headquarters are in Mumbai.1

Many of India's leading financial institutions have a stake in the NCDEX. As of 2021,
significant shareholders included Life Insurance Corporation of India (LIC), the National Stock
Exchange of India Limited (NSE), and the National Bank for Agricultural and Rural
Development (NABARD).2

ORGIN OF NCDEX

National Commodity & Derivatives Exchange Limited (NCDEX) is an Indian online

commodity and derivative exchange based in India. It is under the ownership of Ministry of
Finance , Government of India. It has an independent board of directors and provides a
commodity exchange platform for market participants to trade in commodity derivatives. It is
a government company, incorporated on 23 April 2003 under the Companies Act, 1956 and
obtained its Certificate for Commencement of Business on 9 May 2003. It commenced
operations on 15 December 2003.
As of 31 July 2013, NCDEX has 848 registered members and client base of about 20 Lakhs
and offers trading on more than 49,000 terminals across 1,000 centers in India. It facilitates
deliveries of commodities through a network of over 594 accredited warehouses through
eight warehouse service providers, with holding capacity of around 1.5 million tonnes and
offers average deliveries of 1 lakh MT at every contract expiry. NCDEX has offices in
Mumbai, Delhi, Ahmedabad, Indore, Hyderabad, Jaipur, and Kolkata.[1]

KEY TAKEAWAYS
The National Commodity & Derivatives Exchange (NCDEX) is a commodities exchange
dealing primarily in agricultural commodities in India.

The National Commodity & Derivatives Exchange is located in Mumbai but has offices across
the country to facilitate trade.

Exchanges like NCDEX have also played a key role in improving Indian agricultural practices.

Barley, wheat, and soybeans are some of the leading agricultural commodities traded on the
NCDEX.

Understanding the National Commodity & Derivatives Exchange

The National Commodity & Derivatives Exchange (NCDEX) is one of the top commodity
exchanges in India based on value and the number of contracts. It is second only to the Multi
Commodity Exchange (MCX), which is focused on energy and metals. The National
Commodity & Derivatives Exchange is located in Mumbai but has offices across the country to
facilitate trade.

The exchange featured futures contracts on 23 agricultural commodities and options on seven
agricultural commodities as of 2021.2 It also offers clearing services for derivatives contracts
traded on the exchange.

India is a world power in terms of agriculture. It is one of the largest producers of wheat, rice,
milk, and many types of fruits and vegetables. The size of India’s agriculture sector is somewhat
hidden internationally because the populous nation consumes much of what it produces.
However, increasing farm-level productivity is making India's strength in agriculture more
apparent.3 The NCDEX plays a critical role in India's growing agriculture sector.

Benefits of the NCDEX

In establishing and maintaining an online futures market for crops, NCDEX has helped
increase market transparency. The exchange assists Indian farmers in the price discovery
process. The NCDEX enables them to price their goods more accurately even if they are not
active in the futures market. Intermediaries, who are known as commission agents, previously
controlled much of the market information in India. The introduction of online commodity
exchanges like NCDEX reduces the cost of price data for farmers by cutting out the
middlemen.

Exchanges like NCDEX have also played a key role in improving Indian agricultural practices.
By standardizing the quality specifications of various products through contracts, the NCDEX
has raised quality awareness. Farmers in India increasingly focus on testing requirements and
enacting farming practices that result in consistently high-quality crops.4

The NCDEX is still young by some standards, but traders and large market participants are
already using contracts to hedge and speculate. This trend is likely to continue as India's
agricultural sector grows in terms of productivity and exports.

Examples of Commodities on the NCDEX

Barley, wheat, and soybeans are some of the leading agricultural commodities traded on the
NCDEX. The exchange also hosts some contracts that are global benchmarks for commodities
like coriander, as well as commodities such as steel, cotton, palm oil, and guar. The NCDEX
also manages three agricultural commodities indexes, one based on soybeans, one on guar, and
one a composite of several agricultural products.

NCDEX is seen as a significant source of information on spices, as India is the leading producer
and consumer of spices in the world.
PROJECT 4
 What are Commodities?
Commodities are assets or goods that are essential in everyday life. They include basic and
movable goods that can be purchased and sold, except for actionable claims and money. Metals
such as gold and silver, agricultural produce like sugar, wheat and coffee are common examples
of commodities. There are broadly two categories of commodities: soft and hard commodities,
also known as, agricultural and non-agricultural. The price of commodities fluctuates as per the
demand and supply in the market.

A Commodity Derivative is a part of commodity trading and is defined as a contract that derives
its value from the commodity that will be squared off on a set future date. Commodity derivative
contracts are used to reduce the risk associated with price uncertainty. To further understand how
you can trade in commodities, the instruments described below provide better clarity.

TRADING INSTRUMENTS IN COMMODITY MARKETS

Commodity derivatives trading includes both Futures and Options for trading.

Commodity Futures is an agreement to buy or sell the commodity at a set time and price in the
future. Commodity Futures are available to trade in stock exchanges for participation by retail
investors, corporates and hedgers. On the other hand, Options, by nature, can be classified as
calls and puts.

Calls give the buyer the right but not the obligation to buy a pre-fixed quantity of the underlying
asset at a given price on or before a given future date. Puts give the buyer the right but not
obligation to sell a pre-fixed quantity of the underlying asset at a given price on or before a given
date.

The exchanges that offer commodity trading in India are:

• Multi Commodity Exchange – MCX
• National Commodity and Derivatives Exchange – NCDEX

• National Multi Commodity Exchange – NMCE

• Indian Commodity Exchange – ICEX
• Ace Derivatives Exchange – ACE

• The Universal Commodity Exchange – UCX

Apart from The NSE and BSE which offer stocks, bonds, and currency derivatives trading, the
above-listed exchanges primarily offer commodity segments. Further, there are many types of
commodity derivatives available for trading through these exchanges. They include:

• Bullions - Gold & Silver

• Base metals - Copper, Zinc & Aluminium
• Energy - Crude Oil & Natural Gas
• Pulses - Barley & Maize
• Oilseeds - Castor Seed & Soybean

• Spices - Jeera, Turmeric & Coriander

How to trade in Derivative instruments?

Many factors affect commodity prices, such as the demand and supply of the commodity,
government trade policies, the global economic situation, currency movements, geopolitical
tensions, market sentiments, investment funds, and seasonal cycles.

From an investor's perspective, there are many advantages of investing in the commodities
markets. These include diversification, protection from inflation, liquidity, and trading on lower
margins. For retail investors, trading in the commodity market is much easier as it does not
require one to have in-depth knowledge of the fundamentals in contrast to stock trading. It is
majorly based on supply and demand.

For instance, if the monsoon is good, the price of agricultural commodities tend to fall, and if the
monsoons are below normal, their prices may rise. Similarly, if the overall global economy is
booming, the demand for commodities and prices tend to rise, whereas if the economy is in
recession, the prices may fall.
With credible experience and a strong customer outreach team, IIFL is a behemoth broker in
India and offers broking services in various categories of equity, commodities, currency,
derivatives and so on. Trader Terminal, the proprietary trading terminal of IIFL offers the
convenience of trading in commodities by providing flexibility of access, holistic research, and
expert analysis.

Final Word
Your commodity trading strategy should be developed as per the financial objectives and
riskbearing capability. With the right plan, commodity trading can prove to be profitable.

USING COMMODITES FOR HEDGING

Let’s look at some basic examples of the futures market, as well as the return prospects and risks.

For simplicity's sake, we assume one unit of the commodity, which can be a bushel of corn, a
liter of orange juice, or a ton of sugar. Let's look at a farmer who expects one unit of soybean to
be ready for sale in six months’ time. Assume that the current spot price of soybeans is $10 per
unit. After considering plantation costs and expected profits, he wants the minimum sale price to
be $10.10 per unit, once his crop is ready. The farmer is concerned that oversupply or other
uncontrollable factors might lead to price declines in the future, which would leave him with a
loss.

Here are the parameters:

• Price protection is expected by the farmer (minimum $10.10).

• Protection is needed for a specified period of time (six months).
• Quantity is fixed: the farmer knows that he will produce one unit of soybean during the
stated time period.
• His aim is to hedge (eliminate the risk/loss), not speculate.

Futures contracts, by their specifications, fit the above parameters:

• They can be bought or sold today for fixing a future price.

• They are for a specified period of time, after which they expire.
• The quantity of the futures contract is fixed.
• They offer hedging.

Assume a futures contract on one unit of soybean with six months to expiry is available today
for $10.10. The farmer can sell this futures contract (short sell) to gain the required protection
(locking in the sale price).

How This Works: Producer Hedge

If the price of soybeans shoots up to say $13 in six months, the farmer will incur a loss of $2.90
(sell price-buy price = $10.10-$13.00) on the futures contract. He will be able to sell his actual
crop produce at the market rate of $13, which will lead to a net sale price of $13 - $2.90 =
$10.10.

If the price of soybeans remains at $10, the farmer will benefit from the futures contract ($10.10
- $10 = $0.10). He will sell his soybeans at $10, leaving his net sale price at $10 + $0.10 =
$10.10
If the price declines to $7.50, the farmer will benefit from the futures contract ($10.10 - $7.50 =
$2.60). He will sell his crop produce at $7.50, making his net sale price $10.10 ($7.50 + $2.60).

In all three cases, the farmer is able to shield his desired sale price by using futures contracts. The
actual crop produce is sold at available market rates, but the fluctuation in prices is eliminated by
the futures contract.

Hedging is not without costs and risks. Assume that in the first above-mentioned case, the price
reaches $13, but the farmer did not take a futures contract. He would have benefited by selling at
a higher price of $13. Because of futures position, he lost an extra $2.90. On the other hand, the
situation could have been worse for him the third case, when he was selling at $7.50. Without
futures, he would have suffered a loss. But in all cases, he is able to achieve the desired hedge.

How This Works: Consumer Hedge

Now assume a soybean oil manufacturer who needs one unit of soybean in six months’ time. He
is worried that soybean prices may shoot up in the near future. He can buy (go long) the same
soybean future contract to lock the buy price at his desired level of around $10, say $10.10.

If the price of soybean shoots up to say $13, the futures buyer will profit by $2.90 (sell pricebuy
price = $13 - $10.10) on the futures contract. He will buy the required soybean at the market
price of $13, which will lead to a net buy price of -$13 + $2.90 = -$10.10 (negative indicates net
outflow for buying).

If the price of soybeans remains at $10, the buyer will lose on the futures contract ($10 - $10.10
= -$0.10). He will buy the required soybean at $10, taking his net buy price to -$10 - $0.10 =
$10.10

If the price declines to $7.50, the buyer will lose on the futures contract ($7.50 - $10.10 =
$2.60). He will buy required soybean at the market price of $7.50, taking his net buy price to
$7.50 - $2.60 = -$10.10.
In all three cases, the soybean oil manufacturer is able to get his desired buy price, by using a
futures contract. Effectively, the actual crop produce is bought at available market rates. The
fluctuation in prices is mitigated by the futures contract.

Risks

Using the same futures contract at the same price, quantity, and expiry, the hedging requirements
for both the soybean farmer (producer) and the soybean oil manufacturer (consumer) are met.
Both were able to secure their desired price to buy or sell the commodity in the future. The risk
did not pass anywhere but was mitigated—one was losing on higher profit potential at the
expense of the other.

Both parties can mutually agree with this set of defined parameters, leading to a contract to be
honored in the future (constituting a forward contract). The futures exchange matches the buyer
or seller, enabling price discovery and standardization of contracts while taking away
counterparty default risk, which is prominent in mutual forward contracts.

Challenges to Hedging

While hedging is encouraged, it does come with its own set of unique challenges and
considerations. Some of the most common include the following:

• Margin money is required to be deposited, which may not be readily available. Margin
calls may also be required if the price in the futures market moves against you, even if
you own the physical commodity.
• There may be daily mark-to-market requirements.
• Using futures takes away the higher profit potential in some cases (as cited above). It can
lead to different perceptions in cases of large organizations, especially the ones having
multiple owners or those listed on stock exchanges. For example, shareholders of a sugar
company may be expecting higher profits due to an increase in sugar prices last quarter
but may be disappointed when the announced quarterly results indicate that profits were
nullified due to hedging positions.
 • Contract size and specifications may not always perfectly fit the required hedging
coverage. For example, one contract of Arabica coffee "C" futures covers 37,500 pounds
of coffee and may be too large or disproportionate to fit the hedging requirements of a
producer/consumer.2 Small-sized mini-contracts, if available, might be explored in this
case.
• Standard available futures contracts might not always match the physical commodity
specifications, which could lead to hedging discrepancies. A farmer growing a different
variant of coffee may not find a futures contract covering his quality, forcing him to take
only available robusta or arabica contracts. At the time of expiry, his actual sale price
may be different than the hedge available from the robusta or arabica contracts.
• If the futures market is not efficient and not well regulated, speculators can dominate and
impact the futures prices drastically, leading to price discrepancies at entry and exit
(expiration), which undo the hedge.

USING COMMODITES FOR SPECULATION

What is a Speculator?

The speculator makes his or her money through buying and selling assets such as derivatives
contracts that allow him/her to control assets such as commodities without ever directly handling
them. For instance, commodities speculators don't arrange shipment and storage for the
commodities that they control as a hedger might. Instead, they simply bet on price movements
and close out their positions before they expire.

This hands-off approach has given speculators the erroneous image of aloof financiers jumping
into markets they care nothing about in order to make profits from the producers—the salt-ofthe-
earth types that legislators are always claiming to defend. But this means that speculators take on
a great deal of risk for themselves. If the price of wheat falls, a long speculator loses all of that
value, while a food producer who has hedged by buying wheat futures will still benefit from
buying cheaper physical wheat to make their products despite the declining value of their futures.
Therefore, speculators can stand to make a lot, but also lose a lot.
Avoiding Shortages

The most obvious function that people overlook when criticizing speculators is their ability to
head off shortages in certain commodities. Shortages are dangerous because they lead to price
spikes or rationing of resources. If a drought kills off half the yield of hay in a given year, it's
natural to expect the price of hay to double in the fall. On wider economies of scale, however,
these shortages are not as easy to spot. That's why commodities speculators help to keep an eye
on overall production, recognizing shortages and moving product to places of need (and
consequently higher profit) through intermediaries—the middlemen who use futures contracts
to control their costs. In this sense, speculators act as financiers to allow the middleman to keep
supply flowing around the world.

A speculator should thus not be confused with the middleman or broker. Our economy would not
be able to grow much if we only had access to the products we need or want that were produced
nearby. More often than not, every product in your house has at least some component that
required an international voyage to get there. The markup of the middleman accounts for the
overhead costs used to ship, sort, bag and display those products in a store near you, plus some
profit to keep the middleman fulfilling this function. This gets maple syrup to Hawaii, Korean
laptops to New York, and other products to destinations where a higher profit can be realized.

More than merely financing middlemen, speculators influence prices of commodities, currencies
and other goods by using futures to encourage stockpiling against shortages. Just because we
want cheap oil or mangoes doesn't mean we should blame speculators when prices rise. More
often, other factors, such as OPEC and tropical hurricanes, have raised the risk of a more volatile
price in the future, so speculators raise prices now to smooth down the potentially larger future
price. A higher price dampens current demand, decreasing consumption and prompting more
resources—more people to take up mango growing or more funds for oil exploration—to go into
increasing stockpiles. This price smoothing means that, while you might not appreciate paying
more for gas or a mango, you will always be able to find some.

When we leave the contained world of commodities and look into one of the largest markets in
the world, foreign exchange (forex), we can see how speculators are essential for keeping
international trade and finance on-level and preventing currency manipulation. Governments are
labeled as some of the most blatant manipulators. Governments want more money to fund
programs while also wanting a robust currency for international trade. These conflicting interests
encourage governments to peg their currencies while inflating away true value to pay for
domestic spending. It's currency speculators, through shorting and other means, that keep
governments honest by speeding up the consequences of inflationary policies.

Preventing Manipulation

While people may recognize speculators' importance in preventing shortages and smoothing
prices, very few will associate speculation with guarding against manipulation -- the very bad
behavior that people mistake speculators for engaging in. In markets with many different
speculators participating, it is much harder to pull off a large-scale manipulation and much more
costly to attempt it (and even costlier upon failing). Unusual price action in Mr.
Copper and Silver Thursday are examples of ongoing manipulations that eventually collapsed as
more market speculators entered opposing trades betting against unusually high prices in
cornered markets. To avoid manipulation in markets we need more speculation, not less.

In thinly traded markets, prices are necessarily more volatile, and the chance for manipulation is
increased because a just few market participants can have a much bigger impact. In markets with
no speculators, the power to manipulate prices shifts between producers and middlemen/buyers
according to the health of the crop or yield of a commodity. These 'minimonopolies" and
monopsonies result in more volatility being passed on to consumers in the form of varying
prices. As speculators see these volatile markets as trading opportunities, they enter and smooth
out the price action and reduce the manipulative tendencies.

ARBITRAGE TRADING IN COMMODITIES

In general, commodities need storage space and transportation to make them available across the
world. Also, they are traded in different forms across the markets. Many times there is a
difference in the price of a commodity in spot and futures markets and also across exchanges.

This difference in price creates an arbitrage opportunity wherein the commodities can be
purchased and sold in different markets at different rates, to generate returns for the investor with
minimum or no-risk. The individual who identifies the arbitrage opportunity across markets and
is involved in commodity trading is called a commodity arbitrageur.

PRECONDITIONS FOR ARBITRAGE OPPORTUNITY:

Below are some preconditions needed for an arbitrage opportunity to exist:

● The given asset is priced differently across different markets.

● The two assets having identical cash-flows must trade at different prices.

● The asset has different future and current trading prices.

Let’s look at the different arbitrage strategies you can opt for while trading in commodities.

1. CASH AND CARRY ARBITRAGE

The cash and carry strategy aims to take advantage of pricing inefficiencies for an asset in the
spot and futures market to generate profits without any risk. The arbitrageur purchases a long
position in the said commodity and simultaneously sells a position through a futures contract for
the same asset. The arbitrageur carries the asset until the expiry of the contract and delivers as
per the futures contract. This is also called as basis trading sometimes.

For example, An asset currently trades at Rs100 with an additional cost of Rs 5 as carrying cost.
Also, there is a futures contract available for the same asset at Rs 108. The arbitrageur, upon
identifying this opportunity invests as per cash and carry strategy to generate a profit of Rs 3.

The strategy is profitable only if the cash inflow upon selling as per futures contract exceeds the
acquisition and carrying cost of the asset. Also, this strategy is not always completely risk-free.
The additional carrying cost may sometimes increase that brings down the profit margin.
2. FUTURES SPREAD
As per this strategy, the arbitrageur takes advantage of the price difference between two futures
contracts of the same asset or commodity. It is focused on buying a futures contract for a
commodity and selling it as per another futures contract to generate profits. Spread trades are less
volatile and lower the risk in trading as compared to straight futures trading.

For example, let’s say that a commodity X march 2019 contract is trading at Rs 500 per unit and
another contract of commodity X June 2019 is trading at Rs 450 per unit. Now the arbitrageur
can decide at the time of expiry of the march 2019 contract whether he wishes to sell the march
futures contract and buy the June futures contract. It depends on how the arbitrageur perceives
future prices.

3. INTER-EXCHANGE STRATEGY
Inter-exchange is another strategy that can help you in the arbitrage trade of commodities. The
arbitrageur exploits the price difference for the same commodity on different exchanges for the
same contract expiry. This difference in price across exchanges calls for arbitrage opportunity.
The price difference of the same commodity mainly happens due to liquidity, instability, and
specifications of the contract.

For example, if the ABC March 2019 futures contract is trading at Rs 500 per unit on exchange 1
whereas it is trading at Rs 550 per unit on exchange 2. Upon identifying this opportunity, the
arbitrageur can buy the futures contract from exchange 1 and sell it as per the futures contract on
exchange 2, thereby making a profit of Rs 50 per unit.
4. INTER-COMMODITY STRATEGY
This strategy is applicable when the arbitrageur is dealing in two different but related
commodities. The two commodities are purchased and sold in the same exchange on the same
contract month to take advantage of the price difference for generating profits.

For example, arbitrage can be created between mustard seed, mustard oil, and related products, to
generate profits from the price differences. Let’s say the price of mustard seed is Rs 1600 per
ton, in the June 2019 futures market whereas the price of mustard oil is Rs 1500 per ton in the
same futures market.

Now if the arbitrageurs perceive that this difference of 100 Rs may increase or decrease as per
the current market situation, he can buy the mustard seed June contract and sell off the mustard
oil June contract or vice versa as per his market understanding.

THE END