Commodity Derivatives

Name: Shabnam (2006 – 2008)

Title: Commodity Derivatives

Summary

“Commodity Derivatives”

A commodity derivatives market (or exchange) is, in simple terms, nothing

more or less than a public marketplace where commodities are contracted
for purchase or sale at an agreed price for delivery at a specified date. These
purchases and sales, which must be made through a broker who is a
member of an organized exchange, are made under the terms and
conditions of a standardized futures contract. Commodity prices do vibrate
more rapidly and provide profitable opportunities, accordingly recessions,
depressions and booms offer many opportunities to scoop up profits.
Exchange Traded Derivatives can be broadly classified into:

• Futures
• Options
The size of the commodities markets in India quite significant, of the
country's GDP of Rs13,20,730 crore (Rs13,207.3 billion). Commodities
constitute almost 48% of our GDP. Commodity derivatives in India have a
chequered history.

Commodity derivatives, which were traditionally developed for risk

management purposes, are now growing in popularity as an investment tool.
The commodity derivatives market is a direct way to invest in commodities
rather than investing in the companies that trade in those commodities.
India's No.1 online trading platform, Integrated Online Platform, Unbiased
Approach, Member of both NCDEX & MCX, Daily market outlook report before
market opens and intra-day calls during the trading hours, Comprehensive
research reports on various commodities enabling companies to understand
the basic fundamentals of the market are some reasons why companies
invest in commodity market.

Even though the commodity derivatives market has made good progress in
the last few years, the real issues facing the future of the market have not
been resolved. Agreed, the number of commodities allowed for derivative
trading have increased, the volume and the value of business has zoomed,
but the objectives of setting up commodity derivative exchanges may not be
achieved and the growth rates witnessed may not be sustainable unless
these real issues are sorted out as soon as possible.

Conclusion

The trade in global commodity market are worth US $600 billion, India
should put in place world standard trading exchanges to tap this huge global
commodities market while protecting the interests of the domestic farmers
from sharp price fluctuations. For achieving this goal, we have to equip
ourselves with the appropriate markets instruments and institutions by
building a commodity trading exchange of global standards, India has an
opportunity to chase a US$ 600 billion market opportunity, this would have
to be done through connecting village mandis and the urban markets
through commodity exchanges.

Amidst the turmoil of a risky market, stiff competition and many introduction
failures, the commodity derivatives industry needs a conceptual model that
incorporates all aspects relevant to the success and failure of commodity
derivatives. In order to meet this need, a new and integrative approach
towards commodity derivatives management is needed, which makes it
easier to gain insight into the viability of new commodity derivatives before
introduction, to assess and improve the viability of existing commodity
derivatives
At a time when India is fast catching up with the world’s leading
manufacturing centers and being home to back office work of the leading
global companies, new multi commodity exchanges, using latest
technologies, can help accelerate the process and also help financial markets
to allocate finance to right sectors. It’s a right step in the direction of
integration with the global commodity markets.

India being a developing country where majority of population is still

dependent on the agriculture, modern commodities exchanges can be used
as tool to improve the life of such people, by making commodities market
more efficient.

Instability of commodity prices has always been a major concern of the

producers, processors, traders as well as the consumers in an agriculture
-dominated country like India. Commodity exchanges provides a mechanism
to lock-in prices, thus insulating the participants from the adverse price risk.

Commodity market helps the farmer by signaling him the price that is
expected to prevail in future, so he can decide which crop to grow, thus
making his expectations aligned with the market. Farmers can also cover
their risk by locking in the price by selling their crop in futures market
(selling futures). Farmers’ direct exposure to price fluctuations, for instance,
makes it too risky for many farmers to invest in otherwise profitable
activities. There are various ways to cop with this problem. Apart from
increasing the stability of the market, various actors in the farm sector can
better manage their activities in an environment of unstable prices through
commodity exchanges.

It must be ensured that this system (futures) actually benefits the farmers,
and not just traders. For this, central and state government agencies have to
take necessary steps, including rapid expansion of rural warehousing
facilities.
Modern commodities market namely MCX, NCME, NCDEX use latest
technology in their operations, they are transparent, demutualised, and
investor friendly. All these attributes, help them in attracting retail investors
and farmers thereby increasing the depth in the market and making it more
efficient.

But there are problems as there are 22 exchanges which trade in only a few
commodities. Despite the different systems of exchanges, the combined
volumes of trading of all exchanges are marginal compared to production
levels. These exchanges are not transparent in their operations, limited and
closed in nature of membership. All the measures to reform them have been
met with stiff resistance from these exchanges and only one or two have
agreed to reform themselves.

Also the derivatives trading in the securities market means most of its
infrastructure and skills can be used by the commodity derivatives market
and they can work together. There is also a proposal to use regional stock
exchanges for trading in commodity derivatives.

In the end all one can say is that there is huge potential in commodity
derivatives market, if are able to tap this potential, this would change the
lives of our farmers and provide new investment opportunities to the
investors in the country.

All this would require a concentrated effort on the part of central and state
governments and the trading community. Rules and regulations must be
harmonized across different states and trading community should be
encouraged to adopt modern trading practices.

The above article was extracted from dissertations by the students

of Skyline College. Skyline College is amongst the top MBA and BBA
institutes in Delhi, Gurgaon (NCR)