Commodity Market in India

Commodity Market in IndiaJoseph Anbarasu on 12 1 - 2011

Commodity marketA 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

IntroductionA revolution in Commodity derivatives and risk managementCommodity options banned in India between 1952 and 2002Commodity market began from 2003 onwardsAlmost all stock exchanges have commodity market segments apart from 3 national level electronic exchangesAlmost Eighty commodities are in the list nowThree Electronic ExchangesThe 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).

HistoryCotton Trade Association started futures trading in 1875Derivatives 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 1939In 1943, forward trading was prohibited in oilseeds and some other commodities including food-grains, spices, vegetable oils, sugar and cloth.

After IndependenceThe Parliament passed Forward Contracts (Regulation) Act, 1952The 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 EffectThe 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 freelyThe 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 ContractsA futures contract is an agreement for buying or selling a commodity for a predetermined delivery price at a specific future time.They are Standardized ContractsTraded in Future Exchanges (Default is taken care)Chicago Board of Trade in 1848

Commodity Options contractsLike 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 optionThe 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 MumbaiTurnover in 2009 was USD 1.24 trillionSixth largest commodity exchangeIt 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).

OrganisationMCX 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 AchievementIt is regulated by the Forward Markets Commission.MCX is India's No. 1 commodity exchange with 83% market share in 2009Competitor 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 tradingThe highest traded item is gold.MCX has several strategic alliances with leading exchanges across the globeAs of early 2010, the normal daily turnover of MCX was about US$ 6 to 8 billionMCX now reaches out to about 800 cities and towns in India with the help of about 126,000 trading terminalsMCX COMDEX is India's first and only composite commodity futures price index

Key shareholdersFinancial 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 IssuesCommodity Options Farmers not beneficiaries in price riseThe Warehousing and StandardizationPhysical Delivery needs backupCash Versus Physical SettlementThe Regulator weak FMCLack of Economy of ScaleTax and Legal bottlenecksAcross States impossibleIndoctrination is ineffectiveThanksNarender 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. 2006http://www.eurojournals.com/finance.htmInvestopediaMCX websiteSEBI website