FAQ - Commodities
What are ‘Commodities’?
Commodities, in simple words, are goods that are unbranded and traded commonly. Gold, silver, rubber, pepper, jute, wheat, sugar, cotton etc., are some of the common commodities.
What is a ‘Commodity market’?
A commodity market (just like the equity market) facilitates trading in various commodities. It may be a spot market or a derivatives market. In a spot market, commodities are bought and sold for immediate delivery, whereas in a derivatives market, various financial instruments based on commodities are traded. These financial instrument such as ‘futures’ are traded in exchanges like Multi Commodity Exchange (MCX) and National Commodity Derivatives Exchange (NCDEX).
Is the concept of trading in commodities futures new in India?
No. Commodity futures market was very much there in earlier times in India. In fact it was one the most vibrant markets till the early 70’s. But due to numerous restrictions the market could not develop further. Now most of these restrictions have been removed, allowing for the development and growth of the commodity futures market in the country
What are ‘Commodity Futures’?
A Commodity future is a derivative instrument for future delivery of a commodity. If you are buying a Gold future, it effectively means you are entering into a contract to buy a fixed quantity of Gold at a future date. The future date is called the ‘contract expiry date’. The fixed quantity is called the ‘contract size’. These futures can be bought and sold through the computer terminals that are connected to the exchanges (MCX and NCDEX), just like the shares in stock market.
Who can buy/sell commodity futures?
Commodity futures can be made use of by any investor, producer, trader etc. For a producer of a commodity, selling of futures ensure that he can sell a particular quantity of his commodity at a particular price. For an investor, who is not interested in physical transaction of commodities, these futures act as good investments? A commodity trader can use futures to make sure that he is guarded against any change in prices.
What is the need for futures trading in commodities?
Futures trading in commodities results in transparent and fair price discovery on account of large-scale participation of entities associated with different value chains. It reflects views and expectations of a wider section of people related to a particular commodity. It also provides effective platform for price risk management for all segments of players ranging from producers, traders and processors to exporters/importers and end-users of a commodity. It also provides hedging, trading and arbitrage opportunities to market players.
Why should I invest in commodity futures? I am already investing in stock markets.
Commodity markets work independently of the equity market and debt market. You must have heard of investment advisors asking you to diversify your portfolio. What they essentially mean is to put your eggs in various baskets so that you are saved from any catastrophe. The commodity market is one such a basket, which allows you to diversify your risks. For e.g., when the stock market returns go down it is not necessary that the Gold prices also fall down. So if you are equity or a debt market investor you have all the more reasons to invest in commodities.
Are the commodity markets smaller in size than equity markets?
In the present condition, it is true. But world over the commodity markets are multiple times bigger than equities markets. In India, most of the commodity derivatives were introduced only from December ‘03. However the Government is contemplating various measures to make these markets bigger and lucrative. The MCX traded value was to the tune of Rs.8587.55 Crores on 20th January 2006 and NCDEX also clocked a record traded value of Rs.7197 Crores on 22nd August 2005. There are efforts going on to allow mutual funds to invest in commodities.
What commodities markets offer?
Commodities market essentially represents another kind of organised market just like the stock market and the debt market. However, commodities market, because of its unique nature lends to the benefits of a wide spectrum of people like investors, importers, exporters, producers, corporate etc.,
If you are an importer or an exporter, commodities futures can help you in the following way:
Hedge against price fluctuations – If you are an exporter of a particular commodity, the price at which you export is generally decided before-hand and so any fluctuation in your procurement prices affect your bottom-line substantially. Similarly an importer also suffers due to variations in the local commodity prices. Commodity futures help you to procure or sell the commodities at a price decided months before the actual transaction, thereby ironing out any change in prices that happen subsequently.
If you are a producer of a commodity, futures can help you as follows:
- Lock-in the price for your produce – If you are a farmer, there is every chance that the price of your produce may come down drastically at the time of harvest. By taking positions in commodity futures you can effectively lock-in the price at which you wish to sell your produce
- Assured demand – Any glut in the market can make you wait unendingly for a buyer.
Selling commodity futures contract can give you assured demand at the time of harvest.
If you are a large scale consumer of a product, here is how this market can help you:
- Control your cost – If you are an industrialist, the raw material cost may dictate the final price of your output. Any sudden rise in the price of raw materials can compel you to pass on the hike to your customers and make your products unattractive in the market. By buying commodity futures, you can fix the price of your raw material.
- Ensure continuous supply – Any shortfall in the supply of raw materials can stall your production and make you default on your sale obligations. You can avoid this risk by buying a commodity futures contract by which you are assured of supply of a fixed quantity of materials at a pre-decided price at the appointed time.
Who is the regulatory body for commodity futures? SEBI ? RBI ?
No, not the Securities and Exchange Board of India or the Reserve Bank of India. The Forward Markets Commission (FMC) is the regulatory body for commodity futures/forward trade in India. The commission was set up under the Forward Contracts (Regulation) Act of 1952. It is responsible for regulating and promoting futures/forward trade in commodities. The FMC is headquartered in Mumbai while its regional office is located in Kolkata. The address and other details are mentioned below
Forward Markets Commission, Ministry of Consumer Affairs, Food and Public Distribution, (Department of Consumer Affairs), Government of India, "Everest", 3rd floor, 100, Marine Drive, Mumbai - 400 002. Tel: (022) 22811262/22811429, Fax: (022) 22812086.
Email: email@example.com , Website: www.fmc.gov.in
How many exchanges are there in the country for commodities future trading?
There are some 21 commodity exchanges in India. However most of them are regional, offline (non screen-based) and commodity specific, hence these are almost inoperative. Significantly the government has recently allowed four national level multi-commodity exchanges to trade in all permitted commodities.
•National Multi Commodity Exchange of India Ltd, Ahmedabad (NMCE)- - www.nmce.com. This is presently working on-line and trading in many active commodities like castor seed/oil, rapeseed and mustard seed/oil, aluminum, soybean/oil, pepper, gold, silver etc.
•National Board of Trade, Indore (N-BOT)--www.nbotind.org. This is also presently working but not completely on-line, screen-based. In this exchange maximum trades are carried out in soy oil.
•National Commodity and Derivative Exchange, Mumbai (NCDEX)-- www.ncdex.com. The exchange is being promoted by ICICI Bank, National Stock Exchange (NSE), Life Insurance Corporation and NABARD. It is more or less on the lines of the NSE of the capital market.
•Multi Commodity Exchange of India Ltd, Mumbai (MCX)-- www.mcxindia.com. The exchange is promoted mainly by professionals and supported by Financial Technology (FT). The exchange has started operations from November 10 and has offered gold, silver and castor seed in the first phase of trading facility.
Which commodities are available for trading in derivative markets?
Initially following commodities in various categories are expected to be available for trading through both the exchanges (MCX and NCDEX):
•Oil and oil seed
•Grains and pulses
•Spices and plantation
Many more commodities are likely to be added in due course of time.
Are any transaction duty charges imposed on commodity futures contracts, as in the case of stocks?
Although FMC does not levy any transaction charges as of now but the respective commodity exchanges have levied transaction charges. Transaction charges are in the range of Rs.4 to Rs.10 per lakh / per contract, which may differ for each commodity.
Do I need to pay sales tax on all trades? Is registration mandatory?
No. If the trade is squared off no sales tax is applicable. The sales tax is applicable only in case of trade resulting into delivery. Normally it is the seller's responsibility to collect and pay the sales tax. The sales tax is applicable at the place of delivery. Those who are willing to opt for physical delivery need to have sales tax registration number.
Are Options also allowed in Commodity Derivatives?
No. Options in goods are presently prohibited under Section 19 of the Forward Contracts (Regulation) Act, 1952. No exchange or person can organize or enter into or make or perform options in goods. However the market expects the government to permit options trading in commodities soon.
Are any additional margin/brokerage/charges imposed in case a client wants to take delivery of goods?
Yes. In case of delivery, the margin during the delivery period increases to 20-25% of the contract value.
How is it possible to sell, when one doesn’t own a commodity?
One doesn't need to have commodity physically or to own a contract for the commodity to enter into a sale contract in the futures market. The contract is simply an agreement to sell the physical commodity at a later date or sell it short. It is possible to repurchase the contract before the maturity, thereby dispensing with delivery of goods.
How will the clearing and settlement take place?
The clearing and settlement will take place through institutions/banks arranged by the exchanges. NCDEX has tied up with NSCCL for clearing purpose. The clearing banks being Canara Bank,HDFC,ICICI,UTI Bank. MCX has tied up with HDFC Bank, BOI, UTI Bank, UBI and IndusInd Bank for providing clearing and settlement facilities.
What is the settlement date?
MTM will be cash-settled by exchange on T+1 basis i.e., next working day after the trading day. However in case of delivery, the settlement date may be five to seven days after the expiry as per contract specifications and exchange rules. The settlement procedure is also available on the related exchange site.
What will be the commodity derivatives market timing?
MCX and NCDEX : Monday to Friday, 1st session market hours of 10.00am to 5.00pm (All commodities) and 2nd session market hours of 5.00pm to 11.55pm (On selective commodities).
Saturday – 10.00 am to 2.00pm
Is there any notice period if someone wants to take or give delivery?
Yes. The buyer/seller has to give his intention for delivery for each contract as per rules and regulations of the exchange and contract specifications.
What is the date of expiry?
At NCDEX generally the contracts will expire on the 20th day of each month. If the 20th happens to be a holiday the expiry day will be the previous working day.
At MCX the expiry day will generally be the 15th of every month. If the 15th happens to be a holiday the expiry day will be the previous working day.
However the contract period and the expiry dates vary from commodity to commodity.
How many contracts will be available for futures trading? Of three calendar months as in case of equities?
Generally three or more consecutive calendar month contracts will be available and each contracts are valid for a minimum period of 3 months.
How much margin is applicable in the commodities market? How is it arrived at?
As in stocks, in commodities also the margin is calculated by VaR system. Normally it is between 4-10% of the contract value. The margin is different for each commodity. Just like in equities, in commodities also there is a system of initial margin and mark-tomarket (MTM) margin. The margin keeps changing depending on the change in price and volatility
Will there be separate trading terminals/systems for commodity futures?
Yes. Since the exchanges are separate, the VSATs, trading terminals, risk management systems, contract notes etc all will be independent of those for equity futures.
Is delivery mandatory in commodity futures contract trading?
No. It's not mandatory. However there is always a provision for delivery in commodity futures trading to ensure that the future prices are in conformity with the underlying. The right for delivery is normally with the seller; the buyer/seller has to express his intention for delivery about five to seven days before the expiry. However provisions vary from exchange to exchange. The market lot for delivery is normally different (higher than the trading lot). The contracts which are not assigned for delivery will be settled in cash.