Project Report On Commodity Markets

Indian Commodities Market I.
INTRODUCTION TO COMMODITIES MARKETS
The vast geographical extent of India and her huge population is aptly complemented by the size of her market. The broadest classification of the Indian Market can be made in terms of the commodity market and the bond market. The commodity market in India comprises of all palpable markets that we come across in our daily lives. Such markets are social institutions that facilitate exchange of goods for money. The cost of goods is estimated in terms of domestic currency. India Commodity Market can be subdivided into the following two categories: Wholesale Market Retail Market Considering the present growth rate, the total valuation of the Indian Retail Market is estimated to cross Rs. 10,000 billion by the year 2010. Demand for commodities is likely to become four times by 2010 than what it was in 2009. 1.1 COMMODITY MARKET IN INDIA A market is conventionally defined as a place where buyers and sellers meet to exchange goods or services for a consideration. This consideration is usually money. In an Information Technology-enabled environment, buyers and sellers from different locations can transact business in an electronic marketplace. Hence the physical market place is not necessary for the exchange of goods or services for a consideration. Electronic trading and settlement of transactions has created a revolution in global financial and commodity markets.
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Indian Commodities Market
COMMODITY MARKET
Precious Metal
Other metals
Gold, Silver
Aluminum, Zinc, Brass, etc
Agriculture
Energy
Gold, Silver
Gold, Silver
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1.2 DEFINITION OF COMMODITY Any product that can be used for commerce or an article of commerce which is traded on an authorized commodity exchange is known as commodity. The article should be movable of value, something which is bought or sold and which is produced or used as the subject or barter or sale. In short commodity includes all kinds of goods. Forward Contracts (Regulation) Act (FCRA), 1952 defines goods as every kind of movable property other than actionable claims, money and securities. In current situation, all goods and products of agricultural (including plantation), mineral and fossil origin are allowed for commodity trading recognized under the FCRA. The national commodity exchanges, recognized by the Central Government, permits commodities which include precious (gold and silver) and non-ferrous metals: cereals and pulses; ginned and un-ginned cotton; oilseeds, oils and oilcakes; raw jute and jute goods; sugar and gur; potatoes and onions; coffee and tea; rubber and spices. Etc. In the world of business, a commodity is an undifferentiated product whose market value arises from the owners right to sell rather than to use. Example commodities from the financial world include oil (sold by the barrel), wheat, bulk chemicals such as sulfuric acid and even pork bellies.
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1.3 COMMODITY EXCHANGE

A brief description of commodity exchanges are those which trade in particular commodities, neglecting the trade of securities, stock index futures and options etc., In the middle of 19th century in the United States, businessmen began organizing market forums to make the buying and selling of commodities easier. These central market places provided a place for buyers and sellers to meet, set quality and quantity standards, and establish rules of business. Agricultural commodities were mostly traded but as long as there are buyers and sellers, any commodity can be traded. The major commodity markets are in the United Kingdom and in the USA. 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) Multi Commodity Exchange of India Limited ( MCX) National Multi-Commodity Exchange of India Limited ( NMCEIL) All the exchanges have been set up under overall control of Forward Market Commission (FMC) of Government of India.
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II. EVOLUTION OF COMMODITY MARKET

Commodities future trading was evolved from need of assured continuous supply of seasonal agricultural crops. The concept of organized trading in commodities evolved in Chicago, in 1848. But one can trace its roots in Japan. In 19th century Chicago in United States had emerged as a major commercial hub. So that wheat producers from Mid-west attracted here to sell their produce to dealers & distributors. Due to lack of organized storage facilities, absence of uniform weighing & grading mechanisms producers often confined to the mercy of dealers discretion. These situations lead to need of establishing a common meeting place for farmers and dealers to transact in spot grain to deliver wheat and receive cash in return. Gradually sellers & buyers started making commitments to exchange the produce for cash in future and thus contract for futures trading evolved; Whereby the producer would agree to sell his produce to the buyer at a future delivery date at an agreed upon price. Trading of wheat in futures became very profitable which encouraged the entry of other commodities in futures market. This created a platform for establishment of a body to regulate and Supervise these contracts. Thats why Chicago Board of Trade (CBOT) was established in 1848. In 1870 and 1880s the New York Coffee, Cotton and Produce Exchanges were born. Agricultural commodities were mostly traded but as long as there are buyers and sellers, any commodity can be traded. In 1872, a group of Manhattan dairy merchants got together to bring chaotic condition in New York market to a system in terms of storage, pricing, and transfer of agricultural products. The largest commodity exchange in USA is Chicago Board of Trade, The Chicago Mercantile Exchange, the New York Mercantile Exchange, the New York Commodity Exchange and New York Coffee, sugar and cocoa Exchange. Worldwide there are major futures trading exchanges in over twenty countries including Canada, England, India, France, Singapore, Japan, Australia and New Zealand.
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Indian Commodities Market III. DIFFERENT COMMODITY EXCHANGE MARKETS IN THE WORLD
COUNTRY United States of America EXCHANGE
Chicago Board of Trade (CBOT) Chicago Mercantile Exchange New York Cotton Exchange New York Board of Trade The London International Financial Futures Options Exchange The London Metal Exchange The Winnipeg Commodity Exchange Brazilian Futures Exchange Commodities Sydney Futures Exchange Ltd. Beijing Commodity Exchange Shanghai Metal Exchange Hong Kong Futures Exchange Tokyo International Financial Futures Exchange Kuala Lumpur commodity Exchange New Zealand Futures and Options Exchange Ltd Singapore commodity Exchange Ltd Le Nouveau Marche MATIF Italian Derivatives Market Amsterdam Exchanges option Traders The Russian Exchange Petersburg Futures Exchange The Spanish Options Exchange Citrus Fruit and Commodity Futures Market of Valencia
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United Kingdom
Canada Brazil Australia People s Republic of China Hong Kong Japan Malaysia New Zealand Singapore France Italy Netherlands Russia Spain
IV.
HISTORY OF COMMODITY MARKET IN INDIA
The history of organized commodity derivatives in India goes back to the nineteenth century when Bombay Cotton Trade Association started futures trading in 1875, about a decade after they started in Chicago. Over the time derivatives 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). 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- are the ultimate regulatory authority. 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 good sand registration of brokers with Forward Markets Commission. The Government accepted most of these recommendations and futures trading was permitted in all recommended commodities.
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Indian Commodities Market V. COMMODITY MARKETS IN INDIA
Today, commodity exchanges are purely speculative in nature. Before discovering the price, they reach to the producers, endorsers, and even the retail investors, at a grassroots level. It brings a price transparency and risk management in the vital market. By Exchange rules and by law, no one can bid under a higher bid, and no one can offer to sell higher than someone elses 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.In India there are 25 recognized future exchanges, of which there are four 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 four exchanges are: i. ii. iii. iv. National Commodity & Derivatives Exchange Limited (NCDEX) Mumbai, Multi Commodity Exchange of India Limited (MCX) Mumbai National MultiCommodity Exchange of India Limited (NMCEIL) Ahmadabad. Indian Commodity Exchange Limited (ICEX) , Gurgaon
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THERE ARE OTHER REGIONAL COMMODITY EXCHANGES SITUATED IN DIFFERENT PARTS OF INDIA.
MAJOR REGIONAL COMMODITY EXCHANGES IN INDIA

a) BATINDA COMMODITY & OIL EXCHANGE LTD. b) THE BOMBAY COMMODITY EXCHANGE c) THE RAJKOT SEEDS OIL AND BULLION MERCHAT d) THE KANPUR COMMODITY EXCHANGE e) THE MEERUT AGRO COMMODITY EXCHANGE THE SPICES AND OILSEEDS EXCHANGE (SANGI) f) AHEMDABAD COMMODITY EXCHANGE g) VIJAY BEOPAR CHAMBER LTD. (MUZAFFARNAGAR) h) INDIA PEPPERS AND SPICE TRADE ASSOCIATION (KOCHI) I) RAJDHANI OILS AND SEEDS EXCHANGE (DELHI) j) THE CHAMBER OF COMMERCE (HAPUR) k) THE EAST INDIA COTTON ASSOCIATION (MUMBAI) l) THE CENTRAL COMMERCIAL EXCHANGE (GWALIOR) m) THE EAST INDIA JUTE & HESSIAN EXCHANGE OF INDIA (KOLKATA) n) FIRST COMMODITY EXCHANGE OF INDIA (KOCHI) o) BIKANER COMMODITY EXCHANGE LTD. (BIKANER) p) THE COFEE FUTURE EXCHANGE LTD. (BANGALORE) q) SUGAR INDIA LTD. (MUMBAI)
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Indian Commodities Market VI. INDIAN COMMODITY MARKET STRUCTURE
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6.1 COMMODITIES TRADED IN INDIA
FIBERS & MANUFACT URERS
PULSES
SPICES
OTHERS
COMMODITIES
VEGETABLES
METALS
EDIBLE OIL
ENERGY PRODUCTS
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6.2 COMMODITY FUTURE MARKET
i.
Evolution of the commodity futures trading in India and present status
Organized futures market evolved in India by the setting up of "Bombay Cotton Trade Association Ltd." in 1875. In 1893, following widespread discontent amongst leading cotton mill owners and merchants over the functioning of the Bombay Cotton Trade Association, a separate association by the name "Bombay Cotton Exchange Ltd." was constituted. Futures trading in oilseeds were organized in India for the first time with the setting up of Gujarati Vyapari Mandali in 1900, which carried on futures trading in groundnut, castor seed and cotton. Before the Second World War broke out in 1939 several futures markets in oilseeds were functioning in Gujarat and Punjab. Futures 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 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. In due course several other exchanges were also created in the country to trade in such diverse commodities as pepper, turmeric, potato, sugar and gur (jag gory). After independence, the Constitution of India brought the subject of "Stock Exchanges and futures markets" in the Union list. As a result, the responsibility for regulation of commodity futures markets devolved on Govt. of India. A Bill on forward contracts was referred to an expert
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committee headed by Prof. A.D.Shroffand Select Committees of two successive Parliaments and finally in December 1952Forward Contracts (Regulation) Act, 1952, was enacted. The Act provided for 3-tierregulatory system; (a) An association recognized by the Government of India on the recommendation of Forward Markets Commission, (b) The Forward Markets Commission (it was set up in September 1953) and, (c) The Central Government Forward Contracts (Regulation) Rules were notified by the Central Government July, 1954. The Act divides the commodities into 3 categories with reference to extent of regulation, viz; The commodities in which futures trading can be organized under the auspices of recognized association. The Commodities in which futures trading is prohibited. Those commodities which have neither been regulated for being traded under the recognized association nor prohibited are referred as Free Commodities and the association organized in such free commodities is required to obtain the Certificate of Registration from the Forward Markets Commission. In the seventies, most of the registered associations became inactive, as futures as well as forward trading in the commodities for which they were registered came to be either suspended or prohibited altogether. The Khusro Committee (June 1980) had recommended reintroduction of futures trading in most of the major commodities , including cotton, kapas, raw jute and jute goods and suggested that steps may be taken for introducing futures trading in commodities, like potatoes, onions, etc. at appropriate time. The government, accordingly initiated futures trading in Potato during the latter half of 1980 in quite a few markets in Punjab and Uttar Pradesh.
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After the introduction of economic reforms since June 1991 and the consequent gradual trade and industry liberalization in both the domestic and external sectors, the Govt. of India appointed in June 1993 one more committee on Forward Markets under Chairmanship of Prof. K.N. Kabra. The Committee submitted its report in September 1994. The majority report of the Committee recommended that futures trading be introduced in 1) Basmati Rice 2) Cotton and Kapas 3) Raw Jute and Jute Goods 4) Groundnut, rapeseed/mustard seed, cottonseed, sesame seed, sunflower seed, safflower seed, copra and soybean, and oils and oilcakes of all of them. 5) Rice bran oil 6) Castor oil and its oilcake 7) Linseed 8) Silver and 9) Onions. The committee also recommended that some of the existing commodity exchanges particularly the ones in pepper and castor seed, may be upgraded to the level of international futures markets. The liberalized policy being followed by the Government of India and the gradual withdrawal of the procurement and distribution channel necessitated setting in place a market mechanism to perform the economic functions of price discovery and risk management. The National Agriculture Policy announced in July 2000 and the announcements of Finance Minister in the Budget Speech for 2002-2003 were indicative of the Governments resolve to put in place a mechanism of futures trade/market. As a follow up the Government issued notifications on 1.4.2003permitting futures trading in the commodities, with the issue of these notifications futures trading is not prohibited in any commodity. Options trading in commodity are, however presently prohibited.
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ii. OBJECTIVES OF COMMODITY FUTURES Hedging with the objective of transferring risk related to the possession of physical assets through any adverse moments in price. Liquidity and Price discovery to ensure base minimum volume in trading of a commodity through market information and demand supply factors that facilitates a regular and authentic price discovery mechanism. Maintaining buffer stock and better allocation of resources as it augments reduction in inventory requirement and thus the exposure to risks related with price fluctuation declines. Resources can thus be diversified for investments. Price stabilization along with balancing demand and supply position. Futures trading leads to predictability in assessing the domestic prices, which maintains stability, thus safeguarding against any short term adverse price movements. Liquidity in Contracts of the commodities traded also ensures in maintaining the equilibrium between demand and supply. Flexibility, certainty and transparency in purchasing commodities facilitate bank financing. Predictability in prices of commodity would lead to stability, which in turn would eliminate the risks associated with running the business of trading commodities. This would make funding easier and less stringent for banks to commodity market players.
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iii. BENEFITS OF COMMODITY FUTURES MARKETS
The primary objectives of any futures exchange are authentic price discovery and an efficient price risk management. The beneficiaries include those who trade in the commodities being offered in the exchange as well as those who have nothing to do with futures trading. It is because of price discovery and risk management through the existence of futures exchanges that a lot of businesses and services are able to function smoothly.
Price Discovery:Based on inputs regarding specific market information, the demand and supply equilibrium, weather forecasts, expert views and comments, inflation rates, Government policies, market dynamics, hopes and fears, buyers and sellers conduct trading at futures exchanges. This transforms in to continuous price discovery mechanism. The execution of trade between buyers and sellers leads to assessment of fair value of a particular commodity that is immediately disseminated on the trading terminal. Price Risk Management: Hedging is the most common method of price risk management. It is strategy of offering price risk that is inherent in spot market by taking an equal but opposite position in the futures market. Futures markets are used as a mode by hedgers to protect their business from adverse price change. This could dent the profitability of their business. Hedging benefits who are involved in trading of commodities like farmers, processors, merchandisers, manufacturers, exporters, importers etc. Import- Export competitiveness: The exporters can hedge their price risk and improve their competitiveness by making use of futures market. A majority of traders which are involved in physical trade internationally intend
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to buy forwards. The purchases made from the physical market might expose them to the risk of price risk resulting to losses. The existence of futures market would allow the exporters to hedge their proposed purchase by temporarily substituting for actual purchase till the time is ripe to buy in physical market. In the absence of futures market it will be meticulous, time consuming and costly physical transactions. Predictable Pricing:The demand for certain commodities is highly price elastic. The manufacturers have to ensure that the prices should be stable in order to protect their market share with the free entry of imports. Futures contracts will enable predictability in domestic prices. The manufacturers can, as a result, smooth out the influence of changes in their input prices very easily. With no futures market, the manufacturer can be caught between severe short-term price movements of oils and necessity to maintain price stability, which could only be possible through sufficient financial reserves that could otherwise be utilized for making other profitable investments. Benefits for farmers/Agriculturalists:Price instability has a direct bearing on farmers in the absence of futures market. There would be no need to have large reserves to cover against unfavorable price fluctuations. This would reduce the risk premiums associated with the marketing or processing margins enabling more returns on produce. Storing more and being more active in the markets. The price information accessible to the farmers determines the extent to which traders/processors increase price to them. Since one of the objectives of futures exchange is to make available these prices as far as possible, it is very likely to benefit the farmers. Also, due to the time lag between planning and production, the market-determined price information disseminated by futures exchanges would be crucial for their production decisions.
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Credit accessibility: The absence of proper risk management tools would attract the marketing and processing of commodities to high-risk exposure making it risky business activity to fund. Even a small movement in prices can eat up a huge proportion of capital owned by traders, at times making it virtually impossible to pay back the loan. There is a high degree of reluctance among banks to fund commodity traders, especially those who do not manage price risks. If in case they do, the interest rate is likely to be high and terms and conditions very stringent. This possesses a huge obstacle in the smooth functioning and competition of commodities market. Hedging, which is possible through futures markets, would cut down the discount rate in commodity lending. Improved product quality:The existence of warehouses for facilitating delivery with grading facilities along with other related benefits provides a very strong reason to upgrade and enhance the quality of the commodity to grade that is acceptable by the exchange. It ensures uniform standardization of commodity trade, including the terms of quality standard: the quality certificates that are issued by the exchangecertified warehouses have the potential to become the norm for physical trade. Commodities as an asset class for diversification of portfolio risk:Commodities have historically an inverse correlation of daily returns as compared to equities. The scenes of daily returns favors commodities, thereby indicating that in a given time period commodities have a greater probability of providing positive returns as compared to equities. Another aspect to be noted is that the Sharpe ratio of a portfolio consisting of different asset classes is higher in the case of a portfolio consisting of commodities as well as equities. Thus, an Investor can effectively minimize the portfolio risk
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arising due to price fluctuations in other asset classes by including commodities in the portfolio. Commodity derivatives markets are extremely transparent:In the sense that the manipulation of prices of a commodity is extremely difficult due to globalization of economies, thereby providing for prices benchmarked across different countries and continents. For example, gold, silver, crude oil, natural gas, etc. are international commodities, whose prices in India are indicative of the global situation. An option for high net worth investors:With the rapid spread of derivatives trading in commodities, the commodities route too has become an option for high net worth and savvy investors to consider in their overall asset allocation. Useful to the producer:Commodity trade is useful to the producer because he can get an idea of the price likely to prevail on a future date and therefore can decide between various competing commodities, the best that suits him. Useful for the consumer:Commodity trade is useful for the consumer because he gets an idea of the price at which the commodity would be available at a future point of time. He can do proper costing/financial planning and also cover his purchases by making forward contracts. Predictable pricing and transparency is an added advantage.
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iv.
USING OF COMMODITY FUTURES:
HEDGERS
producers-farmers consumers-refineries,food refineries,food processing companies
SPECULATORS
brokerage houses retail investors and people involved in commodity spot trading
ARBITRAGEURS
brokerage houses people trading in commodity spot markets and warehousing companies
v.
WHAT IS THE ROLE OF COMMODITY FUTURES MARKET AND WHY DO WE NEED THEM?
One answer that is heard in the financial sector is `we need commodity futures markets so that we will have volumes, brokerage fees, and something to trade''. I think that is missing the point. We have to look at futures market in a bigger perspective -- what is the role for commodity futures in India's economy? In India agriculture has traditionally been an area with heavy government intervention. Government intervenes by trying to maintain buffer stocks, they try to fix prices, and they have import import-export export restrictions and a host of other interventions. Many economists think that we could have major benefits from liberalization of the agricultural sector.
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In this case, the question arises about who will maintain the buffer stock, how will we smoothen the price fluctuations, how will farmers not be vulnerable that tomorrow the price will crash when the crop comes out, how will farmers get signals that in the future there will be a great need for wheat or rice. In all these aspects the futures market has a very big role to play. If you think there will be a shortage of wheat tomorrow, the futures prices will go up today, and it will carry signals back to the farmer making sowing decisions today. In this fashion, a system of futures markets will improve cropping patterns. Next, if I am growing wheat and am worried that by the time the harvest comes out prices will go down, then I can sell my wheat on the futures market. I can sell my wheat at a price which is fixed today, which eliminates my risk from price fluctuations. These days, agriculture requires investments -- farmers spend money on fertilizers, high yielding varieties, etc. They are worried when making these investments that by the time the crop comes out prices might have dropped, resulting in losses. Thus a farmer would like to lock in his future price and not be exposed to fluctuations in prices. The third is the role about storage. Today we have the Food Corporation of India which is doing a huge job of storage, and it is a system which -- in my opinion -- does not work. Futures market will produce their own kind of smoothing between the present and the future. If the future price is high and the present price is low, an arbitrager will buy today and sell in the future. The converse is also true, thus if the future price is low the arbitrageur will buy in the futures market. These activities produce their own "optimal" buffer stocks, smooth prices. They also work very effectively when there is trade in agricultural commodities; arbitrageurs on the futures market will use imports and exports to smooth Indian prices using foreign spot markets.
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Indian Commodities Market vi. Trading in commodity futures
The commodity trading system consists of certain prescribed steps or stages as follows:
Trading
order execution position limit reporting price limits
Clearing
matching registering clearing clearing limit notation margining
Settlements
marking to market receipts and payments delivering upon expiration or maturity
Entities in the trading system a. Trading cum Clearing members TCMs can trade and clear either on their own account or on behalf of their clients including participants. Each TCM has a unique ID and can have more than one user.
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b. Professional clearing members PCMs are members of NSCCL. The PCM membership entitles the members to clear trades executed though trading cum Clearing Members both for themselves and/or on behalf of their clients. Methods of trading: a. Open outcry:Open outcry trading is a face- to-face and highly activated form of trading used on the floors of the exchanges. In open outcry system the futures contracts are traded in pits. Normally one type of contract is traded in each pit. b. Electronic trading:Electronic trading: Electronic trading systems have become increasingly popular in the past decade. The driving factor for the rise in the popularity of these systems is their potential to improve efficiency and lower the cost of transactions. In addition, electronic trading systems make exchanges available to remote investors in real time, which is an important benefit in the present situation of increased trading from remote locations. vii. Components of the system: Computer terminals, where customer orders are keyed in and confirmations are received A host compute that processes trade. A network that links the terminals to the host computer.
viii. Format for tickers: XXXYYYZZZ XXX: Three letters for the commodity YYY: three letters for the grade ZZZ: Three letters for the location E.g.: SYOREFIND: SYO: Soya oil REF: Refined IND: Indore
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Instrument Type is to denote whether the ticker is a future contract or a spot price being disseminate or an options contract. E.g.: COMDTY- Used for commodity spot price dissemination FUTCOM- Used for future on commodity OPTCOM- Used for options on futures on commodity. Contract expiry for futures contract will be written as 20mmmYYYY Mmm - denotes the month, e.g. DEC, JAN etc. YYYY denotes the year e.g. 2005, 2006 etc For spot price, no expiry will be displayed or required ix. Types of orders in futures trading
With electronic trading, a lot of flexibility is available to investors in executing various types of orders. They must familiarize themselves with the various types. The orders can be categorized into time conditions, price conditions and other conditions. Time conditions order Day order: The order is valid for the day on which it is entered. If the order is not executed during the trading session, the system itself will cancel the order at the end of the day. Fresh order has to be entered for the next day. Good till cancelled: It remains in the system till the order is cancelled by the user. The maximum number of days the order will remain in the system will be notified by the Exchange. Good till date: The order will remain in the system up to the date the user has specified, if it is not executed. Immediate or cancel: An immediate or cancel order allows the user to buy or sell a contract as soon as it is entered into the system. If it is not matched or partial match has been done, any balance portion of the contract will be automatically cancelled. All or none order: It is a limit order in which the order will be executed in its fully entirety or not executed.
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Fill or kill order: Like the previous one, it is a limit order. It should be executed immediately and if the order is not executed, it gets cancelled. Limit order: This is an order to buy or sell the futures contract of a commodity at a specified price. Stop Loss order: Stop Loss order is a facility given to the traders/clients to use it to limit their amount of loss, if the futures contracts move against their position. It is an order to buy or sell when the market price reaches the specified level. When the price reaches the point, the order gets triggered and it becomes a market order. For example, a trader has purchased gold futures at Rs.7, 000/He is uncertain about the market movement. He plans to limit his loss, if the prices go down. He will place a stop order if the price falls less than Rs.6900/-. When the market goes down, the stop order gets executed at this price. Other conditions Market Price: Market orders are those for which no price is specified at the time of entering the order. Market on open: This kind of orders will be executed during the market open within the opening range. Market on close: These types of orders are executed on the market close. Spread Order: It is an order in which two positions are taken, i.e. one long position and one short position with different months of maturity in the same commodity or in closely related commodities. The prices of the futures contract tend to go up and down and by entering the spread order, investor would have locked in the price and the amount of profit. The trader will unwind the position depending on the market movement.
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Margin requirements. (a) The initial security deposit paid by a member will be considered as his initial margin deposit for the purpose of allowable exposure limit. Initially, every member is allowed to take exposure up to the level permissible on the basis of such initial deposit. However, if a member wishes to create more exposure, he has to pay additional deposit. (b) If there is a surplus deposit lying with the Exchange towards margin, it is not refunded to the member, unless a written request is received from the member for refund. However, the member continues to get additional exposure limit on account of such additional/surplus deposit. Different types of margins collected by the Exchange are as follows: a. Ordinary (Initial) Margin: Ordinary margin requirement is calculated by applying the margin percentage applicable for a contract on the value of the open position of a member in that contract. If a member has net position in various contracts of the same commodity running concurrently, he is required to pay margin separately on each of these contracts. Similarly, if a member has open position in various commodities, the total amount required is calculated as sum total of margin required in respective of each commodities and contracts separately. The computation methodology in respect of ordinary margin is as follows: Intraday: During the trading session, the margin is calculated on the absolute difference between total sales in value terms and total buy in value terms in respect of all transactions executed in a contract during the day in addition to previous day s open position carried forward at the official closing price of previous day. End of day: At end of the trading session, the margin amount is computed on net position in a contract in quantitative terms multiplied by the official closing price. x.
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b. Special Margin: In case the price fluctuation in a contract during the trading session is more than 50% of the circuit filter limit applicable on that contract compared to the base price of the day, a special margin equivalent to 50% of the circuit filter limit is applied. Such special margin amount is immediately blocked out of available margin deposits of the members having outstanding position in that contract and in case the available margin of a member is not sufficient to cover such special margin required, then a margin call is sent to the member which is required to be remitted by the member immediately. In such case, since the available deposit is already exhausted, he is suspended from trading and such suspension continues during such trading session till collection of required margin amount is completed. If the price volatility reaches 100 % of the circuit filter limit, orders will be accepted by the system only up to the price level equivalent to such circuit filter. c. Delivery Period Margin: When a contract enters into delivery period towards the end of its life cycle, delivery period margin is imposed. Such margin is applicable on both outstanding buy and sales side, which continues up to the settlement of delivery obligation or expiry of the contract, whichever is earlier. The delivery period margin is calculated at the rate specified for respective commodity multiplied by the net open position held by a member in the expiring contract. When a seller submits delivery documents along with surveyor s certificate, his position is treated as settled and his delivery period margin to such extent is reduced. When a buyer pays money for the delivery allocated to him, his delivery period margin is reduced on such quantity for which he has paid the amount. If delivery does not happen with respect to certain open position and is finally settled by way of difference as per the Due Date Rate, the delivery period margin is released only after final settlement of difference arising out of such closing out as per the Due Date Rate.
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xi.
(a)
Matching Rules
The Exchange may launch more than one order book running either parallel or at different time spans, either with the same order matching rules or with different matching rules. The Exchange is also entitled to modify or change the matching rules relevant to any market or order books any time where it is necessary to do so Without prejudice to the generality of the above, the order matching rules will have the following features: Orders in the Normal market will be matched on price -time priority basis. Best buy order shall match with the best sell order.
(b)
(The best buy order would be the one with the highest price and the best sell order would be the one with the lowest price.)
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xii. Settlement
Futures contracts have two types of settlements, the MTM settlement which happens on a continuous basis at the end of each day, and the final settlement which happens on the last trading day of the futures contract.
TYPES OF SETTLEMENTS
DAILY SETTLEMENT
FINAL SETTLEMENT
HANDLE DAILY PRICE FLUCTUATION FOR ALL TRADES (MARK TO THE MARKET) DAILY PROCESS AT END OF THE DAY
DANDLES FINAL SETTLEMENT OF ALL POSITION ON CONTRACT EXPIRY DATE
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a. Daily settlement: mark to the market This is done to take care of daily price fluctuation for all traders. All open positions of the members are marked to market at the end of day and the profit/loss is determined as below: On the day of entering into the contract, it is the difference between the entry value and daily settlement price for that day. On any intervening days, when the member holds an open position, it is the difference between the daily settlement price for that day and the previous day settlement price. On the expiry date if the member has an open position, it is the difference between the final settlement price and the previous day settlement price. Illustration: A clearing member buys one December expiration cotton futures at Rs> 6435 per quintal on December 15. The unit of trading is 11 bales and each contract is for delivery of 55 bales of cotton. The member closes the position on December 19. The MTM profit/losses get added/ deducted from his initial margin on a daily basis. Date Dec 15, 2004 Dec 16, 2004 Dec 17, 2004 Dec 18, 2004 Dec 19, 2004 Settlement Price 6320 6250 6312 6310 6315 MTM -115 -70 +62 -2 +5
Daily MTM settlement flow Information to members- end of trade day T Settlement through designated clearing Bank Arrangement of funds in settlement A/c by member Collection and payment of fund T +1
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Exchange clearing House Member
Margin
Daily MTM Settlement
Initial Margin Any special margin
Daily P/L For Positions closed out MTM of open position
Member s bank A/c
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Indian commodities market

Settlement banking operations
CLIENT 1
BROKER 1 Exchange Clearing House
Clearing Bank (HDFC) CLIENT 2 BROKER 2
b. Final settlement: The settlement done for open Buy and Sell positions on the contract expiry date is called final settlement. On the date of expiry, the final settlement price is the spot price on the expiry day. The prices are collected from the members across the country through polling. The polled bid/ask prices are bootstrapped and the mid of the two bootstrapped is taken as the final settlement price. The responsibility of settlement is on a trading cum clearing member (TCM) for all trades done on his own A/c and his client s trades. A professional clearing member (PCM) is responsible for settling all the participants trades, which he has confirmed to the exchange. xiii. Settlement methods: Physical delivery of the underlying asset Closing out by offsetting position Cash settlement
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a. Physical delivery settlement Members can give and take delivery of commodities by completing the delivery formalities and giving delivery information to the exchange. Entities involved in physical delivery: Accredited warehouse Approved registrar and transfer agents Approved assayer b. Closing out by offsetting position In closing out the opposite transaction is affected to close out the original futures position. A buy contract is closed by a sell contract and a sale contract is closed buy a sell contract. For example, an investor took a long position in Gold futures contract on the January 30 2005 at Rs 6000 can close his position by selling gold futures contract on February 25 2005 at 5780. In this case, over the period of holding the position, he has suffered a loss of Rs 220 per unit. This loss would have been debited from his margin Account over the holding period by way of MTM at the end of each day. c. Cash settlement: Contract held till the last day of trading can be cash settled. When a contract is settled in cash, it is marked to the market at the end of the last trading day and all positions are declared closed. The settlement price on the last trading day is set equal to the closing spot price of the underlying asset ensuring the convergence of future prices and the spot prices. For example an investor took a short position in five long staple cotton futures contracts on December 15 at Rs 6950. On 20th February, the last trading day of the contract, the spot price of long staple cotton is Rs. 6725. This is the settlement price for his contract. As a holder of a short position on cotton, he does not have to actually deliver the underlying cotton, but simply takes away the profit of Rs. 225 per trading unit of cotton in the form of cash.
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Indian commodities market VII. NATIONAL LEVEL COMMODITY EXCHANGES IN INDIA

i. NMCE (National Multi Commodity Exchange of India Ltd.) NMCE is the first demutualised electronic commodity exchange of India granted the National exchange on Govt. of India and operational since 26th Nov, 2002.Promoters of NMCE are, Central warehousing corporation (CWC), National Agricultural Cooperative Marketing Federation of India (NAFED), Gujarat AgroIndustries Corporation Limited (GAICL), Gujarat state agricultural Marketing Board (GSAMB), National Institute of Agricultural Marketing (NIAM) and Neptune Overseas Ltd. (NOL). Main equity holders are PNB. The Head Office of NMCE is located in Ahmadabad. There are various commodity trades on NMCE Platform including Agro and non-agro commodities. ii. NCDEX (National Commodity & Derivates Exchange Ltd.) NCDEX is a public limited co. incorporated on April 2003 under the Companies Act 1956; It obtained its certificate for commencement of Business on May 9, 2003. It commenced its operational on Dec 15, 2003.Promoters shareholders are: Life Insurance Corporation of India (LIC), National Bank for Agriculture and Rural Development (NABARD) and National Stock Exchange of India(NSE) other shareholder of NCDEX are: Canara Bank, CRISIL limited, Goldman Sachs, Intercontinental Exchange (ICE), Indian farmers fertilizer corporation Ltd (IFFCO) and Punjab National Bank (PNB).NCDEX is located in Mumbai and currently facilitates trading in 57 commodities mainly in Agro product. iii. MCX (Multi Commodity Exchange of India Ltd.) Headquartered in Mumbai, MCX is a demutualised nationwide electronic commodity future exchange. Set up by Financial Technologies (India) Ltd. permanent recognition from government of India for facilitating online trading, clearing and settlement operations for future market across the country. The exchange started operation in Nov, 2003. MCX equity partners include, NYSE Euro next, State Bank of India and its associated, NABARD NSE, SBI Life Insurance Co.
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Ltd., Bank of India, Bank of Baroda, Union Bank of India, Corporation Bank, Canara Bank, HDFC Bank, etc.MCX is well known for bullion and metal trading platform. iv. ICEX (Indian Commodity Exchange Ltd.) ICEX is latest commodity exchange of India Started Function from 27 Nov, 09. It is jointly promote by India bulls Financial Services Ltd. and MMTC Ltd. and has Indian Potash Ltd. KRIBHCO and IFC among others, as its partners having its head office located at Gurgaon (Haryana). BSE is also planning to set up a Commodity exchange. UNIQUE FEATURES OF NATIONAL LEVEL COMMODITY EXCHANGES: The unique features of national level commodity exchanges are: They are demutualized, meaning thereby that they are run professionally and there is separation of management from ownership. The independent management does not have any trading interest in the commodities dealt with on the exchange. They provide online platforms or screen based trading as distinct from the open outcry systems (ring trading) seen on conventional exchanges. This ensures transparency in operations as everyone has access to the same information. They allow trading in a number of commodities and are hence multicommodity exchanges. They are national level exchanges which facilitate trading from anywhere in the country. This corollary of being an online exchange.
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Indian commodities market VIII. INTRODUCTION TO DERIVATIVES

i. DERIVATIVES DEFINITION:
Derivative is a product whose value is derived from the value of one or more underlying variables or assets in a contractual manner. The underlying asset can be equity, forex, commodity or any other assets. ii. PRODUCTS OF DERIVATIVES MARKET:
Derivative contracts are of different types. The most common ones are forwards, futures, options, warrant and swaps. Forwards: A forward contract is an agreement between two entitles to buy or sell the underlying assets at a future date, at today s pre-agreed price Futures: A futures contract is an agreement between two parties to buy or sell the underlying assets at a future date, at today s future price. Futures contracts differ from forward contracts in the sense that they are standardized and exchange traded. Options: There are two types of options Calls and Put. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying assets, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. Warrants: Options generally have lives of up to one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-date options are called warrants and are generally traded over- thecounter. Baskets: Basket options on portfolios of underlying assets. The underlying asset is usually a weighted average of assets. Equity index options are a form of basket options.
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Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. Swaptions: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a Swaptions is an option on a forward swap.
iii.
PARTICIPANTS IN DERIVATIVES MARKET:
Participants who trade in the derivatives market can be classified under the following three broad categories: Hedgers: Ones who offset the price risk inherent in any cash market position by taking the opposite position in the futures market. Hedgers use the market to protect their businesses from adverse price changes. Speculator: One who tries to profit from buying and selling future contracts by anticipating future price movements. Arbitragers: Ones simultaneously purchase and sale of similar commodities in different exchanges or in different contracts of the same commodity in one exchange to take advantage of a price discrepancy. iv. FUNCTIONS OF DERIVATIVES: The prices of derivatives converge with the prices of the underlying at the expiration of the derivative contract. Thus derivatives help in discovery of future as well as current prices. The derivatives market helps to transfer risks from those who have them but may not like them to those who have an appetite for them. Derivatives, due to their inherent nature, are linked to the underlying cash market. With the introduction of derivatives, the underlying market witness higher trading volumes because of participation by more players who would not otherwise participate for lack of an arrangement to transfer risk.
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Speculative traders shift to a more controlled environment of the derivatives market. In the absence of an organized derivatives market, speculators trade in the underlying cash markets. Margining, monitoring and surveillance of the activities of various participants become extremely difficult in these kinds of mixed markets. An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for new entrepreneurial activity. Derivatives shave a history of attracting many bright, creative, well-educated people with an entrepreneurial attitude. They often energize others to create new businesses, new products and new employment opportunity, the benefit of which are immense. Derivatives markets help increase savings and investment in the long run. The transfer of risk enables market participants to expand their volume of activity. v. DERIVATIVES MARKETS:
Derivatives can broadly be classified as commodity derivative market and financial derivatives markets. As the name suggest, commodity derivatives market trade contracts for which the underlying asset is a commodity. It can be an agricultural commodity like wheat, soybean, cotton, etc or precious metals. Financial derivatives markets trade contracts that have a financial asset or variable as the underlying.
DERIVATIVES MARKETS
FINANCIAL MARKET
COMMODITY MARKET
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vi. DIFFERENCES BETWEEN SPOT FORWARD/FUTURES TRANSACTION TRANSACTION AND
TRANSACTIONS
SPOT TRANSACTIONS
FUTURE TRANSACTIONS
Using the example of a forward contract, let us try to understand the difference between a spot and derivatives contract. Every transaction has three components: trading, clearing and settlements In spot transaction, the trading, clearing and settlement is the actual process of exchanging money and goods and at the spot. Consider this example. On 1st January2004 B wants to buy some gold. The gold quotes at Rs 6,000 per 10 grams. B payRs12, 000 and get the gold, this is spot transaction. In forward/future contracts trading happens today, but the clearing and settlement happen at the end of the specified period. Now suppose B does not want to buy gold on the 1st January 2004, but wants to buy it a month later. The gold quotes 6,015 per 10 gram. They agree upon the forward price for 20 gram of gold that B wants to buy and B leaves. One month later B pays Rs 12,030 and collects his gold. This is a forward contract.
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Indian commodities market IX. INSTRUMENTS AVAILABLE FOR TRADING
In recent years, derivatives have become increasingly popular due to their applications for hedging, speculation and arbitrage. While futures and options are now actively traded on many exchanges, forward contracts are popular on the OTC market. While at the moment only commodity futures trade on the NCDEX, eventually, as the market grows, we also have commodity options being traded. i. FORWARD CONTRACTS
A Forward contract is a contract between two people who agree to buy/sell a specified quantity of a financial instrument/commodity at a certain price at a certain date in future. For example, Mr. X and Mr. Y. Mr. X is a wholesale sugar dealer and Mr. Y is the prospective buyer. Mr. Y agrees to buy 30 kg of sugar at Rs 15 per kg after three months. The price is arrived at on the basis of prevailing market conditions and future perceptions about the price of sugar. If after three months, the market price of sugar is Rs 20 per kg, then Mr. Y is a gainer and if the price of sugar is Rs 10 per kg, then Mr. X is a gainer. The salient features of forward contract are: They are bilateral contracts and hence exposed to counter party risk. Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality. The contract price is generally not available in public domain. On the expiration date, the contract has to be settled by delivery of the asset. If the party wishes to reverse the contract, it has to compulsorily go to the same counterparty, which often results in high prices being charged.
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Advantages of forward markets Use for hedging Use for speculation Limitations of forward markets Lack of centralization of trading. Illiquidity Counterparty risk ii.
FUTURES MARKET
Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contracts. Its a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, and a standardized time of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 99% of futures transactions are offset this way. Standardized items in a futures contract are: Quantity of the underlying Quality of the underlying The date and the month of delivery The units of price quotation and minimum price change Location of settlement Unlike Equity futures, the commodity future contract expires on the 20th day of the delivery month.
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What are futures? Futuresare standardized financial contracts traded in a futures exchange. A futures contract is an agreement to buy or sell a certain quantity of an underlying asset at a certain time in the future at a predetermined price. When futures contracts are traded, there isnt necessarily an actual delivery of goods. The trader only speculates on the future direction of the price of the underlying asset, which may be a commodity, foreign exchange, bonds, money market instruments, equity or any other item. The terms "buy" and "sell" only indicate the direction the trader expects future prices to take, i.e. he would buy it if he expects the price of the underlying asset to rise in the future and sell if he expects it to fall. Futures contracts are usually closed by making an opposite transaction, i.e. the buyer of the contract sells it before the expiration date. The price at which the contract is traded in the futures market is called the futures price. Futures contracts have one-month, two-month and three-month expiry cycles, and they usually expire on the last Thursday of the respective month. There are two systems that may be followed in the settlement of futures contracts: Futures Rolling Settlement: At the end of each day, all outstanding trades are settled, i.e. the buyer makes payments for securities purchased and the seller delivers the securities sold. In India, futures exchanges function on the T+5 settlement cycle, wherein transactions are settled after 5 working days from the date on which the transaction has been entered. Weekly Settlement Cycle: This system provides the traders a longer time frame to speculate because the settlement is made at the end of each week. There are three categories of participants in the futures market speculators, who bet on the future movement of the price of an asset; hedgers, who try to eliminate the risks involved in the price fluctuations of an asset by
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entering futures contracts; and arbitrageurs, who try to take advantage of the discrepancy b between prices in different markets. While hedgers participate in the market to offset risk, speculators make it possible for hedgers to do so by assuming the risk. Arbitrageurs ensure that the futures and cash markets move in the same direction. Why futures trading? Over the past two decades, food prices have been more volatile than the prices of manufactured goods. The uncertainty of commodity prices leaves a farmer open to the risk of receiving a price lower than the expected price for his yield. At times, the crop prices fall so low that the farmer is unable to repay the loan. Inadequate price risk management is one of the most important reasons for poor farmers remaining poor. Price risk management refers to minimizing the risk involved in commodities trading. Through futures contracts, the risk may be shifted to speculators or traders who are willing to assume the risk. A hedger would try to minimize risk by taking opposite positions in the futures and cash markets. Since the two markets usually move in the same direction, the profits of one market will cover the losses in the other. In the case of a commodity seller, like a farmer or a merchant, futures contracts offer protection from declining prices. Price discovery refers to the process of determining the price level of a commodity based on demand and supply factors. Every trader in the trading pit of a commodities exchange has specific market information like demand, supply and inflation rates. When trades between buyers and sellers are executed, the market price of a commodity is discovered. According to V. Shunmugam, Chief Economist at the Multi Commodity Exchange of India Ltd., commodity futures help policy makers take better preventive measures by indicating price raises beforehand. Apart from the basic functions of price discovery and price risk management, futures contracts have a number of other benefits like providing liquidity, bringing transparency and controlling black marketing.
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Futures contracts can easily be converted into cash, i.e. they are liquid. By buying or selling the contract in order to make profits, speculators provide the capital required for ensuring liquidity in the market. They provide certainty of future revenues or expenditures, hence ensuring concrete cash flows for the user. Futures markets allow speculative trade in a more controlled environment where monitoring and surveillance of the participants is possible. Hence, futures ensure transparency. The transparency benefits the farmers as well by spreading awareness about prices in the open market. Futures also help in standardization of quality, quantity and time of delivery, since these variables are agreed upon by the participants and specified in the futures contract. Distinction between futures and forwards contracts Forward contracts are often confused with futures contracts. However there are some differences between forward contracts and future contracts. Future contracts area significant improvement over the forward contracts as they eliminate counter party risk and offer more liquidity. A futures contract is an agreement between two parties to buy or sell a specified quantity and quality of asset at a certain time in future at a certain price agreed at the time of entering into the contract on the futures exchange. Forward contract is an agreement entered between two parties to buy or sell an asset at a future date for an agreed price. Forward contract is not traded on an exchange. Trading place: A future contract is entered on the centralized trading platform of the exchange. Forward contract is OTC in nature. Size of the contract: Futures contract is standardized in terms of quantity as specified by the exchange. Size of the forward contract is customized as per the terms of agreement between buyer and seller.
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Transparency in contract price: Contract price of futures contract is transparent as it is available on the centralized trading screen of the exchange. Contract price of forward contract is not transparent, as it is not publicly disclosed. Valuation of open position and margin requirement: In case of futures contract valuation of open position is calculated as per official closing price on daily basis and Mark to Market margin requirement exist. In case of forward contract valuation of open position is not calculated on daily basis and there is no provision of Mark to Market margin requirement. Liquidity: Futures contract is more liquid as it is traded on the exchange. Forward contract is less liquid due to customized nature and mutual trade. Counter party risk: In futures contract Clearing House becomes counter party to each transaction, which is called Notation, so counter party risk is nil. In forward contract counterparty risk is high due to decentralized nature of the transaction. Regulations: A government regulatory authority and the exchange regulate futures contract. Forward contract is not regulated by any authority or exchange. Settlement: Futures contract is generally cash settled but option of physical settlement is available. Forward contract is generally settled by physical delivery.
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Delivery: Delivery tendered in case of futures contract should be of standard quantity and standard quality as per contract specification at designated delivery centers of the exchange. Delivery in case of forward contract is carried out at delivery center specified in customized bilateral agreement.
Futures Trade on an organized exchange Standardized contract terms More liquid Requires margin payments Follows daily settlement
Forward OTC (over the counter) in nature Customized contract terms Less liquid No margin payment Settlement happens at end of period
iii.
OPTIONS
As the word suggests option is a contract that gives you an option, but not the obligation to buy or sell something. Unlike futures, there is an option writer who initiates the contract. An option writer is treated as the seller of the contract. The purchase of options requires an up-front payment. Commodity options are totally prohibited in Indian market. Call option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price.
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Put option: A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price. iv. BASIC PAYOFFS
A Payoff is the likely profit/loss that would accrue to a market participant with change in the price of the underlying asset. This is generally depicted in the form of payoff diagrams which show the price of the underlying asset on X-axis ant the profits/loss on the Y-axis.
a. Payoff for futures

Pay off for buyer of futures: long futures The payoff for a person who buys a future contract is similar to the payoff for a person who holds an asset. He has a potentially unlimited upside as well as a potentially unlimited downside. PROFIT
+500
0 5500 6000 6500 GOLD
-500 LOSS
The Figure shows the profits/losses for a long futures position. The investor bought gold when gold futures were trading at Rs. 6000 per 10 gm. If the price of the underlying gold goes up, the gold futures price too would go up and his future
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position starts making profits. If the price of gold falls, the futures price falls too and his futures position starts showing losses.
Payoff for a seller of futures: short position. The payoff for a person who sells a future contract is similar to the payoff for a person who sells an asset. He has a potentially unlimited upside as well as a potentially unlimited downside.
PROFIT +500
6000
6500
7000
-500 LOSS The figure shows the profits and losses for a short futures position. The investor sold cotton futures at Rs. 6500 per quintal. If the price of the underlying cotton goes down, the futures prices also fall, and the short position starts making profits. If the price of the underlying cotton rises, the futures too rise, and the short position starts showing losses.
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Indian commodities market b. Payoff for options

Pay off for buyer of call option: long call Call option give the buyer the right to buy the underlying asset at the strike price specification in the option. The figure shows the profits/loss for the buyer of a three month call option on gold at a strike of Rs 7,000 per 10 gram, bought at premium of Rs 500.
PROFIT
7000
GOLD
500 LOSS
PAYOFF FOR SELLER (WRITER) OF CALL OPTIONS: SHORT CALL The figure shows the profits/loss for the seller of a three month call option on gold at a strike of Rs 7,000 per 10 gram, sold at premium of Rs 500. PROFIT 500 0 7000 GOLD LOSS
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Payoff for buyer of put options: long put The figure shows the profit/loss for the buyer of a three month put option on gold at a strike of Rs 7,000 per 10 gram, bought at premium of Rs 500. PROFIT
0 500 LOSS
7000 GOLD
Payoff for a seller (writer) of put option: short put
PROFIT 500 7000 0 GOLD LOSS
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Indian commodities market X. PARTICIPANTS IN COMMODITIES MARKETS
For a market to succeed/ it must have all three kinds of participants hedgers, speculators and arbitragers. The confluence of these participants ensures liquidity and efficient price discovery on the market. Commodity markets give opportunity for all three kinds of participants. A. HEDGING Many participants in the commodity futures market are hedgers. The use the futures market to reduce a particular risk that they face. This risk might relate to the price of wheat or oil or any other commodity that the person deals in. The classic hedging example is that of wheat farmer who wants to hedge the risk of fluctuations in the price of wheat around the time that his crop is ready for harvesting. By selling his crop forward, he obtains a hedge by locking in to a predetermined price. Hedging does not necessarily improve the financial outcome; indeed, it could make the outcome worse. What it does however is that it makes the outcome more certain. Hedgers could be government institutions, private corporations like financial institutions, trading companies and even other participants in the value chain, for instance farmers, extractors, ginners, processors etc., who are influenced by the commodity prices.
B. SPECULATION
An entity having an opinion on the price movements of a given commodity can speculate using the commodity market. While the basics of speculation apply to any market, speculating in commodities is not as simple as speculating on stocks in the financial market. For a speculator who thinks the shares of a given company will rise. It is easy to buy the shares and hold them for whatever duration he wants to. However, commodities are bulky products and come with all the costs and procedures of handling these products. The commodities futures
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markets provide speculators with an easy mechanism to speculate on the price of underlying commodities. To trade commodity futures on the NCDEX, a customer must open a futures trading account with a commodity derivatives broker. Buying futures simply involves putting in the margin money. This enables futures traders to take a position in the underlying commodity without having to actually hold that commodity. With the purchase of futures contract on a commodity, the holder essentially makes a legally binding promise or obligation to buy the underlying security at some point in the future (the expiration date of the contract). C. ARBITRAGE A central idea in modern economics is the law of one price. This states that in a competitive market, if two assets are equivalent from the point of view of risk and return, they should sell at the same price. If the price of the same asset is different in two markets, there will be operators who will buy in the market where the asset sells cheap and sell in the market where it is costly. This activity termed as arbitrage, involves the simultaneous purchase and sale of the same or essentially similar security in two different markets for advantageously different prices. The buying cheap and swelling expensive continues till prices in the two markets reach equilibrium. Hence, arbitrage helps to equalize prices and restore market efficiency.
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Indian commodities market XI. REGULATORY ISSUES FOR COMMODITY FUTURES TRADING
Government Policies on futures trading
i.
Various government policies still hinder the growth of commodity exchanges. Given the recognized need for India to have efficient exchanges in the face of liberalization and globalization, FMC should take the lead in coordinating with the responsible Ministries and other government entities a change of these policies. This would not necessarily reduce the government's possibilities to intervene in commodity markets, but would ensure that such intervention does not hinder, or even critically damage, commodity futures markets. A first issue is taxes. Different tax treatment of speculative gains and losses discourage many speculators from participating in official futures exchanges, thereby affecting the liquidity of the markets. Hedgers are affected as well: the necessary link between futures and physical market transactions is too rigidly defined. Tax issues need to be clarified so that futures losses can be offset against profits on the underlying physical trade and vice versa. A second problem is stamp duty. Stamp duties on trade in commodity futures exchanges should be nil, except when physical delivery is made. Now, stamp duty can be arbitrarily imposed by the state in which the futures exchange is located. Clarification from the Indian states in which there are exchanges that there will be no arbitrary position on stamp duty is recommended. Third, many institutions (particularly financial institutions but also, in a less direct manner, cooperatives) are not permitted to engage in commodity futures trade. The rules which prevent such engagement need to be modified. Finally, the role of government entities directly involved in commodity trade should be reconsidered. The direct purchasing practices of these entities now damage the potential of commodity exchanges. If a federal or state government wishes to continue direct interventions in commodity markets, it could, if it wished, pass through the commodity exchanges. This would ensure
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effective market intervention (the effect on prices will be immediate), and, as long as done within clear policy guidelines, does not destroy market mechanisms. ii. The forward contracts regulation Act.
The forward contracts (regulation) Act, 1992, a central Act, governs commodity derivatives trading in India, The Act defines various forms of contract. The Act envisages a three-tier regulation. Exchange: The exchange which organizes forward trading I regulated commodities can prepare its own Articles of Association, Rules and Regulations, byelaws and regulate trading on a day to-day basis. FMC (Forward Markets Commission): The commission approves the rules and byelaws of the exchange and provides a regulatory oversight. It also acquires concurrent powers of regulation while approving the rules and byelaws of by making such rules and byelaws under the delegated powers. Central Government: Ministry of Consumer affairs and Public Distribution under the Govt. of India is the ultimate regulatory authority. Only those associations, which are granted recognition by the Government, are allowed to organize forward trading in regulated commodities. Government has the power to suspend trading, call for information, nominate directors of the Exchange etc. Central Govt. has delegated most these powers to FMC.\ iii. Forward market commission
Forward Markets Commission (FMC) headquartered at Mumbai, is a regulatory authority which is overseen by the Ministry of Consumer Affairs and Public Distribution, Govt. of India. It is a statutory body set up in 1953 under the Forward Contracts (Regulation) Act, 1952.
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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.
(a)
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.
(b)
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;
(c)
To make recommendations generally with a view to improving the organization and working of forward markets;
(d)
undertake the inspection of the accounts and other documents of any recognized association or registered association or any member of such association whenever it considerers it necessary. iv. Regulation for Brokers in commodity futures trading
(e) To
Brokers should meet the following requirements: Mandated capital adequacy. The regulators should seek to minimize any risk to investors and threat to the stability of the market from the failure of an institution because it becomes unable to meet its liabilities. Currently, a broker's membership at the exchange is solely dependent upon fulfilling the financial requirements (in form of upfront payment or equity participation, membership, admission fees etc.) levied by the different exchanges. There is a need for mandated capital adequacy for brokers together with measures to monitor that the capital is, in fact, maintained.
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Licensing: In India, there is no requirement of any form of licensing. A broker can start trading once he fulfills the exchange requirements. There is no educational requirement. It is advisable that anyone dealing in futures for clients is registered. To be registered, one would need to: Be a member/employee of an exchange Pass a character assessment e.g., no conviction of fraud. - Pass an examination. Advertising: The Conduct of Business Rules insists that adverting must be fair and not misleading. Additionally, an investment advertisement must contain a risk warning relating to the risks associated with the investments being advertised. The unsolicited oral promotion of services or products, commonly known as cold calling, is also heavily regulated. Customer agreements. Before an exchange member can operate on behalf of a customer a client agreement should be in place. The exchange or the regulator may wish to define the minimum acceptable content of such an agreement. Suitability: A broker needs to check the capacities of his client before undertaking any agreement. Before opening any account for a customer the broker must satisfy himself of the bona fide commercial need for the customer to open the account. He must be satisfied that the customer s quality of management, commodity experience and commodity business knowledge together with their systems and staff will enable them to fulfill the obligations and commitments they undertake when they sign the agreement. Such agreements need to be reviewed regularly and the brokers will need to be sure that the customers continue, at all times, to demonstrate that they are fit and proper persons to be conducting derivatives business.
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Indian commodities market XII. COMPARATIVE ANALYSIS EQUITYMARKETS

FACTORS Percentage Returns Initial Margins Arbitrage Opportunities
OF
COMMODITY
AND
COMMODITY MARKET
EQUITY MARKET
Gold gives 10-15 %returns on Gold Returns in the range of the conservative basis. 15-20 % on annual basis. Lower in the range of 4-5-6% Higher in the range of 25-40% Exists on 1-2 month contracts. There is a small difference in prices, but in case of commodities, which it is in large tonnage makes a huge difference. Price movements are purely based on the supply and demand. Price changes are due to policy changes, changes in tariff and duties. Predictability of future prices is not in the control due to factors like Failure of Monsoon and Formation of Elninos at Pacific. Lower Volatility Significant Arbitrage Opportunities exists.
Price Movements
Price Changes
Future Predictability
Volatility Securities Transaction Securities Transaction Act is Securities Transaction Act is not applicable to commodity applicable to equity markets Act Application
futures trading. trading.
Prices movements based on the expectation of future performance. Price changes can also be due to Corporate actions, Dividend announcements, Bonus shares / Stock splits. Predictability of futures performance is reasonably high, which is supplemented by the History of management performance. Higher Volatility
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XIII. RESEARCH METHODOLOGY

RESEARCH OBJECTIVE: To study the investment patterns, participation, perception and awareness about commodity trading among Indian retail investors. RESEARCH DESIGN: Research design is the basic framework, which provides guidelines of research process once the problem of opportunity is identified. This study helps in collection and analysis of the data. RESEARCH TYPE: Descriptive RESEARCH METHOD: Survey through Questionnaire method RESEARCH SAMPLE SIZE: 100 retail investors from Mumbai region
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1. HOW YOU INVEST IN CAPITAL (SHARE) MARKET? PEOPLE CRITERIA FOR INVESTING INTO SHARE MARKET
intraday trading - 57%
medium term investments 9% long term investments -30%
More than 50% of the people are intraday trader and short term investor. So there will be an opportunity for the commodity markets to convert them to the commodity trading by proper awareness. 2. ARE YOU AWARE ABOUT COMMODITY MARKETS? AWARENESS OF PEOPLE REGARDING COMMODITIES MARKETS
yes - 56% no - 44%
Nearly 50% of the people are unaware about the commodity market. So commodity exchanges and brokers have to take some corrective steps to create the awareness into the general public.
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3. DO YOU INVEST IN COMMODITIES? PEOPLE TRADING INTO COMMODITY MARKET
yes - 22% no - 78%
Only 22% of the people are trading into the commodity market so there is a large market share to cover by creating the proper awareness. 4. WHAT ARE THE REASONS FOR NOT TRADING IN COMMODITY MARKETS? REASONS FOR NOT TRADING IN COMMODITY MARKETS
lack of understanding-34% lack of guidance from brokers-10% no option for-5% warehousing problems-2% influence of macroeconomics-2% big losses-11% big lots(high margin)-5% others-31%
34% of the people are not trading because of lack of understanding. While 31% of the people are not trading because they are not having the time and interest.
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5. WHAT ARE THE VARIOUS COMMODITIES YOU TRADE IN? COMMODITIES IN WHICH PEOPLE ARE MAINLY TRADING
Precious metals (Gold/Silver/Copper)-52% agricultural commodities-19% crude oil-29%
More than 50% of the people are trading into the precious metals like Gold/Silver/Copper. Only 19% of the people are trading into agricultural commodities which are very much lesser than the metals. So we can say that by creating more awareness to the farmers commodity exchanges can get better turnover into agri-commodities. 6. WHAT IS YOUR PURPOSE FOR TRADING IN THE COMMODITY MARKETS? PURPOSE OF TRADING INTO COMMODITIES MARKET
speculation-45% hedging for physical goods-20% investment (delivery purpose)0% arbitrage-15% others-20%
45% of the people are just doing speculation into the commodity markets. O% people are taking the delivery of the commodity.
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7. WHAT FACTORS AFFECT COMMODITIES THE MOST? FACTORS AFFECTING THE COMMODITIES MARKETS
seasons-18% crop harvesting-2% political-14% demand-supply scenario-27% spoy prices-5% others-34%
34% of the people who are falling within the others criteria are believe that commodity market is just speculation so no factors are affecting to it is completely depend on the operators. Only 2% and 5% of the people believed crop harvesting and spot prices. 27% of people believe demand-supply scenario can be a important factor 8. DO YOU FEEL THAT IN LAST COUPLE OF YEARS PRICES OF GENERAL COMMODITIES HAVE INCREASED DUE TO COMMODITY SPECULATIONS?
PRICES HAVE GONE UP DUE TO COMMODITY SPECULATIONS
yes no
86% of the people are believe that price of general commodities have gone up due to commodity speculations.
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FINDINGS: Findings of this Project show that only 8% of the people are investing money in the commodity market at this stage even though 56% respondents are aware about the commodity market. Basically news channel is the main source for awareness regarding commodity markets in the respondents. The main reason for not trading in the commodity market is the lack of understanding and other major reason is that lack of time and interest and also some bad experience in previous investment. Out those who invest in the commodity market, more than half of them invest in the gold, silver and copper. When asked to the people regarding the factors affecting commodity market, 34% respondents reply that speculation is the Broker where they deal. Most of the people think that speculation is responsible for increase in the general price levels of the commodities RECOMMENDATIONS: Nearly 50% of the population is unaware about the commodity markets so it is recommended to commodity exchanges that they have to take some serious actions for creating awareness about these markets to the general public. They can create more and more awareness by arranging seminars targeting general publics and people who are more risk takers into the share markets. News channel is also one of the better sources for creating awareness. In my survey nobody take delivery of the commodities because they are facing the problem of warehousing so commodity exchanges have to take some steps for solving the warehousing problem. Only 20% of the peoples are hedgers into these markets so exchanges can get better turnover by attracting other people who are dealing such commodities.
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Indian commodities market XIV. CONCLUSION

This decade is termed as Decade of Commodities. India is one of the top producers of large number of commodities and also has a long history of trading in commodities and related derivatives. The Commodities Derivatives market has seen ups and downs, but seems to have finally arrived now it has made enormous progress in terms of technology, transparency and trading activity. Interestingly, this has happened only after the Government protection was removed from a number of Commodities, and market force was allowed to play their role. As majority of Indian investors are not aware of organized commodity market; their perception about is of risky to very risky investment. Many of them have wrong impression about commodity market in their minds. It makes them specious towards commodity market. Firstly, we should make the general people think positive about the COMMODITY MARKET as well concerned authorities have to take initiative to make commodity trading process easy and simple and the knowledge can be spread by arranging seminars targeting general publics and people who are more risk takers in stock markets even news channels are better source for creating awareness. There is no doubt that in near future commodity market will become Hotspot for Indian farmers rather than spot market. And producers, traders as well as consumers will be benefited from it. But for this to happen one has to take initiative to standardize and popularize the Commodity Market.
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Indian commodities market XV. REFERENCE/BIBLIOGARPHY

Books and journals COMMODITY FUNDAMENTALS (SPURGA. R.) IUP ON COMMODITY MARKETS: RECENT TRENDS (ALGIRI-D.) DERIVATIVES FAQS BY AJAY SHAH AND SUSAN THOMAS INTRODUCTION TO FUTURES AND OPTIONS MARKETS BY JOHN KOLB NCDEX- A GUIDE TO COMMODITY DERIVATIVES.
Newspapers and Articles ECONOMIC TIMES :- DATED (21ST JUNE 2012) MINT DATED :- (19TH DECEMBER 2011) TIMES OF INDIA :-DATED (9TH JANUARY 2012) Websites http://www.ncdex.com/ http://business.mapsofindia.com http://www.indiainfoline.com/ http://indian-commodity.com/ http://www.bcel.org/ http://www.moneycontrol.com http://www.fmc.gov.in http://www.trade.motilaloswal.com http://www.thefinancials.com http://www.porfolioscience.com
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