Commodity Futures

An investor's quick guide to Commodity Futures

Anand James, Sr. Analyst, Geojit Comtrade Ltd.

Commodity Futures Market works very similar to the popular share market, with the main difference that in commodity futures market, futures contracts are traded whose value is derived from the underlying commodity. Trading is done through commodity exchanges which are regulated by the Forward Market Commission (FMC) which comes under the purview of Government of India’s Ministry of Consumer Affairs Food and Public Distribution. The three national level commodity exchanges in India are Multi Commodity Exchange of India Ltd. (MCX), National Commodity & Derivatives Exchange Ltd.(NCDEX) and the National Multi Commodity Exchange of India Ltd. (NMCE). Their websites: www.mcxindia.com, www.ncdex.com, and www.nmce.com are storehouses of vast information. One can select the exchange on the basis of the commodity of choice, as some commodities have relatively more volume in some exchanges.

Presently, MCX leads in terms of overall volumes, and is the preferred exchange for global commodities like Gold, Crude Oil, Copper, etc. Rubber is very active in NMCE, while a lot of agricultural commodities are very active in NCDEX. Broking houses who are members of these exchanges, provide the trading platform, research reports, and necessary support for the participants to facilitate trading. To start trading, one needs to open an account with any of these brokers. Selection of such brokers can be based on their visibility, research reports, ability to guide you, etc. and there are many equity brokerages who have brought in their experience into this field.

To take an exposure in any commodity, one has to ensure margin in the trading account, which is a percentage of value of that commodity which is fixed and adjusted by the exchange every day depending on its volatility. Once a transaction is executed, be it buy or sell, at the end of the day, and until the position is squared off, difference between the entry level and the day’s closing price gets deducted or added to the margin amount. For every trade, the brokerage charges a percentage normally not exceeding 0.05 percentage of the traded value on which the exchange also charges an exchange levy. Education cess and Service tax on Exchange levy and broking commission, and Stamp duty are the other expenses incurred by the trader. The spectrum of participants involve hedgers who are looking to reduce their risk in their spot transaction, and traders who are looking to enter a directional move that they anticipate and exit before the trend matures. Yet another section of astute traders try to take advantage of the price discrepancies between spot/near month futures and far month futures. Investors in other asset classes also hedge their positions by taking offsetting positions in commodities due to their close correlation with economic fundamentals. Lastly, a smart trader is one who is able to objectively define his/her own risk profile, trading horizon and strategy with clarity. Of course, s/he must be willing to set apart the required time and money.