Commodity Market in

India
Joseph Anbarasu on 12 1 2011

Commodity market
A potato producer could
purchasepotato futures on a
commodity exchange to lock in a
pricefor 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.

Process

Introduction

A revolution in Commodity derivatives and

risk management
Commodity options banned in India between
1952 and 2002
Commodity market began from 2003 onwards
Almost all stock exchanges have commodity
market segments apart from 3 national level
electronic exchanges
Almost Eighty commodities are in the list now

Three Electronic
Exchanges

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).

History

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.

After Independence

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.

Policy Shift Kabra Committee

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.

After Effect

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.

Why Derivatives?

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.

Commodity Futures Contracts

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

Commodity Options contracts

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.

Example

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)

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).

Organisation

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.

MCX Achievement

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

Key shareholders

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

Unresolved Issues

Commodity Options
Farmers not beneficiaries in price rise

The Warehousing and Standardization

Physical Delivery needs backup

Cash Versus Physical Settlement

The Regulator
weak FMC

Lack of Economy of Scale

Tax and Legal bottlenecks
Across States impossible

Indoctrination is ineffective

Thanks

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