Professor Vipin 2015
Commodities Market
History
Commodity trading in India has a long history. In fact, commodity trading in India started much
before it started in many other countries. However, years of foreign rule, droughts and periods of
scarcity and Government policies caused the commodity trading in India to diminish. Commodity
trading was, however, restarted in India recently. Today, apart from numerous regional exchanges,
India has six national commodity exchanges namely, Multi Commodity Exchange (MCX), National
Commodity and Derivatives Exchange (NCDEX), National Multi-Commodity Exchange (NMCE) and
Indian Commodity Exchange (ICEX), the ACE Derivatives exchange ( ACE )and the Universal
commodity exchange (UCX). The regulatory body is Forward Markets Commission (FMC) which was
set up in 1953.
Functions of Commodity Exchange
When most people think of commodities futures exchanges, they probably envision a crowded
trading pit exhibiting complete pandemonium. In spite of the apparent chaos, futures exchanges
operate in an organized manner to provide vital economic functions, facilitating world trade on a
macro level as well as stabilizing farm and corporate incomes on a micro level. Understanding the
functions of the exchanges can help both businesses and investors.
Pricing: Commodities exchanges allow the trading of agricultural products, livestock, foreign
currencies, oil, precious metals and other products and establish prices for products around the
world. Commodities prices are determined by the market forces of supply and demand in the
trading pits of the exchanges by public open outcry. What appears chaotic actually is well-organized,
as brokers, buying and selling for themselves and their clients, use hand signals to trade. Prices
reported from the commodities exchanges are communicated around the world and are used as the
basis for numerous economic and political decisions.
Organizing Markets: Futures exchanges such as the New York Mercantile Exchange and the Chicago
Board of Trade fulfill an essential economic function by providing organized marketplaces with
standardized contracts. Without this function, futures transactions would be negotiated
independently with no structure at all. Each futures exchange maintains its own clearinghouse that
fulfills all transactions. This provides stability to the market, as the clearinghouse acts as the other
party in all transactions. Because traders are buying and selling contracts throughout the day, their
buys and sells may not be equal when trading ends. Traders settle any imbalances once at the end of
the trading day with the exchange rather than settling each trade separately.
Hedging: Merchants, farmers and international firms use the futures exchanges to hedge future
transactions. When a farmer plants his crop of wheat, for example, he does not know what the price
will be at harvest time. To remove the risk of price changes, he sells wheat futures contracts at
planting time. When he sells his crop a few months later, he buys back the futures contacts. If wheat
prices have fallen, he is protected because the futures contracts he buys at harvest cost less than the
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ones he sold at planting. An importing firm can use financial futures contracts in the same manner to
lock in a price for the goods it will be importing later in the year.
Speculating: Speculators fill the important economic function of providing liquidity to an exchange.
With the money that speculators bring to the exchanges, the spread between bid and ask prices is
much narrower than it otherwise would be; commodity prices would fluctuate more erratically
without the participation of speculators. When hedgers buy and sell contracts to cover their risks, it
is the speculative commodity traders who assume those risks, thereby helping stabilize prices.
Organization of Commodity Exchange
The Multi Commodity Exchange of India Limited (MCX), India’s first listed exchange, is a state-of-theart, commodity futures exchange that facilitates online trading, and clearing and settlement of
commodity futures transactions, thereby providing a platform for risk management. The Exchange,
which started operations in November 2003, operates within the regulatory framework of the
Forward Contracts (Regulation) Act, 1952.
MCX offers trading in varied commodity futures contracts across segments including bullion, ferrous
and non-ferrous metals, energy and agricultural commodities. The Exchange focuses on providing
commodity value chain participants with neutral, secure and transparent trade mechanisms, and
formulating quality parameters and trade regulations, in conformity with the regulatory framework.
The Exchange has an extensive national reach, with over 2000 members, operations through more
than 470,000 trading terminals (including CTCL), spanning over 1894 cities and towns across India.
MCX is India’s leading commodity futures exchange with a market share of about 82.82 per cent in
terms of the value of commodity futures contracts traded in 9M FY2014-15.
To ease participation, the Exchange offers facilities such as calendar-spread facility, as also EFP
(Exchange of Futures for Physical) transactions which enables participants to swap their positions in
the futures/ physical markets. The Exchange’s flagship index, the MCXCOMDEX, is a real-time
composite commodity futures price index which gives information on market movements in key
commodities. Other commodity indices developed by the exchange include MCXAgri, MCXEnergy,
and MCXMetal. MCX has been certified to three ISO standards including ISO 9001:2008 quality
management standard, ISO 27001:2005 information security management standard and ISO
14001:2004 environment management standard.
Cash (Physical Market) vs Future Market
A cash market transaction occurs in the present, but a futures market transaction is an agreement
for an exchange of the underlying asset in the future.
Prices in the cash and futures market differ from one another as a direct result of the disparity in the
timing of delivery of the underlying product. After all, if a commodity is going to be delivered at
some point in the future, it must be stored and insured in the meantime. The costs associated with
holding the physical grain until the stated delivery date is referred to as the cost to carry.
Specifically, the costs to carry include items such as storing and insuring the commodity prior to the
date of delivery.
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Naturally, in normal market conditions, the cash price will be cheaper than the futures price due to
the expenses related to carrying the commodity until delivery. Likewise, the near-month futures
price will be cheaper than a distantly expiring futures contract.
Difference Between Physical and Futures Market
The physical markets for commodities deal in either cash or spot contract for ready delivery and
payment within 11 days, or forward (not futures) contracts for delivery of goods and/or payment of
price after 11 days. These contracts are essentially party-to-party contracts, and are fulfilled by the
seller giving delivery of goods of a specified variety of a commodity as agreed to between the
parties.
Rarely are these contracts for the actual or physical delivery allowed to be settled otherwise than by
issuing or giving deliveries. Such situations may arise when unforeseen and uncontrolled
circumstances prevent the buyers and sellers from receiving or taking deliveries. The contracts may
then be settled mutually.
Unlike the physical markets, futures markets trade in futures contracts which are primarily used for
risk management (hedging) on commodity stocks or forward (physical market) purchases and sales.
Futures contracts are mostly offset before their maturity and, therefore, scarcely end in deliveries.
Speculators also use these futures contracts to benefit from changes in prices and are hardly
interested in either taking or receiving deliveries of goods.
Options on Commodity Exchange
In a call option counterparties enter into a financial contract option where the buyer purchases the
right but not the obligation to buy an agreed quantity of a particular commodity or financial
instrument (the underlying) from the seller of the option at a certain time (the expiration date) for a
certain price (the strike price). The seller (or "writer") is obligated to sell the commodity or financial
instrument should the buyer so decide. The buyer pays a fee (called a premium) for this right.
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