Commodity Derivatives


Commodity Derivatives are the first of the derivatives contracts that emerged to hedge against the risk of the value of the agricultural crops going below the cost of production. Chicago Board of Trade was the first organized exchange, established in 1848 to have started trading in various commodities. Chicago Board of Trade and Chicago Mercantile Exchange are the largest commodities exchanges in the world.
It is important to understand the attributes necessary in a commodity derivative contract:
a) Commodity should have a high shelf life – only if the commodity has storability, durability will the carriers of the stock feel the need for hedging against the price risks or price fluctuations involved
b) Units should be homogenous – the underlying commodity as defined in the commodity derivative contract should be the same as traded in the cash market to facilitate actual delivery in the cash market. Thus the units of the commodity should be homogenous
c) Wide and frequent fluctuations in the commodity prices – if the price fluctuations in the cash market are small, people would feel less incentivised to hedge or insure against the price fluctuations and derivatives market would be of no significance. Also if by the inherent attributes of the cash market of the commodity, the cash market of the commodity was such that it would eliminate the risks of volatility or price fluctuations, derivatives market would be of no significance. Taking an oversimplified example, if an investor had purchased 100 tons of rice @ Rs. 10/ kg in the cash market and is of the view that the prices may fall in the future, he may short a rice future at Rs. 10/ kg to hedge against the fall in prices. Now if the prices fall to Rs. 2/ kg, the loss that the investor makes in the cash market may be compensated by squaring of the short position thus eliminating the risk of price fluctuations in the commodity market Commodity derivative contracts are standardized contracts and are traded as per the investors needs. The needs of the investor may be instrumental or convenience, depending upon the needs, the investor would trade in a derivative product. Instrumental risks would relate to price risk reduction and convenience needs would relate to flexibility in trade or efficient clearing process.
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in 1875, since then the market has suffered from liquidity problems and several regulatory dogmas. However in the recent times the commodity trade has grown significantly and today there are 25 derivatives exchanges in India which include four national commodity exchanges; National Commodity and Derivatives Exchange (NCDEX), National Multi- Commodity Exchange of India (NCME), National Board of Trade (NBOT) and Multi Commodity Exchange (MCX).
 It is the largest commodity derivatives exchange in India and is the only commodity exchange promoted by national level institutions. NCDEX was incorporated in 2003 under the Companies Act, 1956 and is regulated by the Forward Market Commission in respect of the futures trading in commodities. NCDEX is located in Mumbai.
MCX is recognised by the government of India and is amongst the world’s top three bullion exchanges and top four energy exchanges. MCX’s headquarter is in Mumbai and facilitates online trading, clearing and settlement operations for the commodoties futures market in the country.

Friday, 02nd Oct 2015, 09:08:50 AM

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