Joseph Anbarasu on 12 – 1 - 2011

A potato producer could purchase potato

futures on a commodity exchange to lock

in a price for a sale of a specified amount

of potato at a future date, while at the

same time a speculator could buy and sell

potato futures with the hope of profiting

from future changes in potato prices.

A revolution in Commodity derivatives and risk management

Commodity options banned in India between 1952 and 2002

Commodity market began from 2003 onwardsAlmost all stock exchanges have commodity

market segments apart from 3 national level electronic exchanges

Almost Eighty commodities are in the list now

The NMCE has most major agricultural commodities and metals under its fold,

The NCDEX, has a large number of agriculture, metal and energy commodities.

MCX also offers many commodities for futures trading (We will see this exchange in detail at the end).

Cotton Trade Association started futures trading in 1875

Derivatives trading started in oilseeds in Bombay (1900), raw jute and jute goods in Calcutta (1912), wheat in Hapur (1913) and in Bullion in Bombay (1920)

The Government of Bombay prohibited options business in cotton in 1939

In 1943, forward trading was prohibited in oilseeds and some other commodities including food-grains, spices, vegetable oils, sugar and cloth.

The Parliament passed Forward Contracts (Regulation) Act, 1952

The Act envisages three-tier regulation: • The Exchange which organizes forward trading in commodities can

regulate trading on a day-to-day basis;

• the Forward Markets Commission provides regulatory oversight under the powers delegated to it by the central Government, and

• the Central Government - Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution is the ultimate regulatory authority.

In 1960s, following several years of severe draughts that forced many farmers to default on forward contracts (and even caused some suicides), forward trading was banned in many commodities considered primary or essential.

Government set up a Committee in 1993 to examine the role of futures trading. The Kabra Committee recommended allowing futures trading in 17 commodity groups.

It recommended certain amendments to Forward Contracts (Regulation) Act 1952, particularly allowing options trading in goods and registration of brokers with Forward Markets Commission.

The Government accepted most of these recommendations and futures trading was permitted in all recommended commodities.

Derivatives do perform a role in risk management led the government to change its stance.

Liberalization facilitates market forces to act freely

The next decade is being touted as the decade of commodities.

The possibility of adverse price changes in future creates risk for businesses.

Derivatives are used to reduce or eliminate price risk arising from unforeseen price changes.

A derivative is a financial contract whose price depends on, or is derived from, the price of another asset.

Two important derivatives are futures and options.

A futures contract is an agreement for buying or selling a commodity for a predetermined delivery price at a specific future time.

They are Standardized Contracts

Traded in Future Exchanges (Default is taken care)

Chicago Board of Trade in 1848

Like futures, options are also financial instruments used for hedging and speculation.

The commodity option holder has the right, but not the obligation, to buy (or sell) a specific quantity of a commodity at a specified price on or before a specified date.

Buyer and Selling. Call Option and Put option The option holder will exercise

the option only if it is beneficial to him; otherwise he will let the option lapse.

For example, suppose a farmer buys a put option to sell 100 Quintals of wheat at a price of $25 per quintal and pays a „premium‟ of $0.5 per quintal (or a total of $50). If the price of wheat declines to say $20 before expiry, the farmer will exercise his option and sell his wheat at the agreed price of $25 per quintal. However, if the market price of wheat increases to say $30 per quintal, it would be advantageous for the farmer to sell it directly in the open market at the spot price, rather than exercise his option to sell at $25 per quintal.

Multi Commodity Exchange (MCX) is an independent commodity exchange based in India.• Established in 2003 and Based in Mumbai

• Turnover in 2009 was USD 1.24 trillion

• Sixth largest commodity exchange

• It was established in 2003 and is based in Mumbai.

MCX offers futures trading in • bullion, ferrous and non-ferrous metals, energy, and a

number of agricultural commodities (menthol oil, cardamom, potatoes, palm oil and others).

MCX has also set up in joint venture the MCX Stock Exchange.

Earlier spin-offs from the company include the National Spot Exchange, an electronic spot exchange for bullion and agricultural commodities, and

National Bulk Handling Corporation (NBHC) India's largest collateral management company which provides bulk storage and handling of agricultural products.

It is regulated by the Forward Markets Commission.• MCX is India's No. 1 commodity exchange with 83% market

share in 2009• Competitor is National Commodity & Derivatives Exchange Ltd • Globally, MCX ranks no. 1 in silver, no. 2 in natural gas, no. 3 in

crude oil and gold in futures trading• The highest traded item is gold.• MCX has several strategic alliances with leading exchanges

across the globe• As of early 2010, the normal daily turnover of MCX was about

US$ 6 to 8 billion• MCX now reaches out to about 800 cities and towns in India with

the help of about 126,000 trading terminals• MCX COMDEX is India's first and only composite commodity

futures price index

Financial Technologies (I) Ltd.,

State Bank of India and its associates,

National Bank for Agriculture and Rural Development (NABARD),

National Stock Exchange of India Ltd. (NSE),

Fid Fund (Mauritius) Ltd.

Corporation Bank, Union Bank of India, Canara Bank, Bank of India, Bank of Baroda , HDFC Bank, SBI Life Insurance Co.

Ltd., ICICI ventures, IL & FS, Merrill Lynch,

and New York Stock

Exchange

Commodity Options • Farmers not beneficiaries in price rise

The Warehousing and Standardization• Physical Delivery needs backup

Cash Versus Physical SettlementThe Regulator

• weak FMC

Lack of Economy of ScaleTax and Legal bottlenecks

• Across States impossible

Indoctrination is ineffective

Narender L. Ahuja for his article “Commodity Derivatives

Market in India: Development, Regulation and Future Prospects” International

Research Journal of Finance and Economics, ISSN 1450-2887 Issue 2 (2006), Euro-

Journals Publishing, Inc. 2006

http://www.eurojournals.com/finance.htm

Investopedia

MCX website

SEBI website