Commodity Market CHAPTER 1
Commodity Market CHAPTER 1
Commodity Market CHAPTER 1
and Institutions
Introduction to Commodity Market
Meaning of Commodity Derivatives
Commodity derivatives markets trade contracts are those for which the
underlying asset is a commodity. It can be an agricultural commodity
like wheat, soybeans, rapeseed, cotton, etc or precious metals like gold,
silver, etc. or energy products like crude oil, natural gas, coal, electricity
etc.
The basic concept of a derivative contract remains the same whether the
underlying happens to be a commodity or a financial asset.
However, there are some features which are very peculiar to commodity
derivative markets
Features peculiar to Commodity Derivatives
The concept of varying quality of asset does not really exist as far as
financial underlyings are concerned. However, in the case of
commodities, the quality of the asset underlying a contract can vary
largely.
Features peculiar to Commodity Derivatives
Physical settlement
The period available for the buyer to take physical delivery is stipulated
by the Exchange. Buyer or his authorised representative in the presence
of seller or his representative takes the physical stocks against the
delivery order.
Physical settlement
The clearing house decides on the delivery order rate at which delivery
will be settled. Delivery rate depends on the spot rate of the underlying
adjusted for discount/ premium for quality and freight costs.
The discount/ premium for quality and freight costs are published by the
clearing house before introduction of the contract. The most active spot
market is normally taken as the benchmark for deciding spot prices.
Features peculiar to Commodity Derivatives
Warehousing
• Earmark separate storage areas as specified by the Exchange for storing commodities;
• Ensure proper grading of commodities before they are stored;
• Store commodities according to their grade specifications and validity period; and
• Ensure that necessary steps and precautions are taken to ensure that the quantity and grade of
commodity, as certified in the warehouse receipt, are maintained during the storage period.
This receipt can also be used as collateral for financing.
Features peculiar to Commodity Derivatives
Help in price discovery - players get to set future prices which are also
made available to all participants
Like any other derivative, a commodity futures contract derives its value
from the underlying commodity.
The spot and futures market are closely interlinked with price and
sentiment in one market affecting the price and sentiment in the other.
Polling is carried out once, twice or thrice a day depending upon the
market timings, practices at the physical market.
Cleansing of data & bootstrapping
The quotes are sorted in ascending order and the extreme quotes are
trimmed from the total quotes
The mean with least standard deviation is the spot price that will be
uploaded
Validation & Checks
If the price rise/fall is justified with the feedback received from the
participants, the price is uploaded in the system after obtaining
necessary approval. Else, re-polling and new bootstrapped price is
arrived at
Trading on NCDEX
The permitted trading lot size for the futures contracts and delivery lot
size on individual commodities is stipulated by the Exchange from time
to time
Clearing & Settlement of trade executed on NCDEX
At NCDEX, after the trading hours on the expiry date, based on the
available information, the matching for deliveries takes place firstly, on
the basis of locations and then randomly, keeping in view the factors
such as available capacity of the vault/ warehouse, commodities already
deposited and dematerialized and offered for delivery etc
Table below explains the MTM for a member who buys one unit of December
expiration Chilli contract at Rs.6435 per quintal on December 15. The unit of
trading is 5 MT and each contract is for delivery of 5 MT. The member closes the
position on December 19. The MTM profit/ loss per unit of trading show that he
makes a total loss of Rs.120 per quintal of trading. So upon closing his position,
he makes a total loss of Rs.6000, i.e (5 x 120 x 10) on the long position taken by
him.
Clearing & Settlement of trade executed on NCDEX
Final Settlement
c) Cash settlement
Final Settlement
a)Physical Delivery
The following types of contracts are presently available for trading on the
NCDEX Platform.
1.Compulsory Delivery
2.Sellers Right
3.Intention Matching
To allocate deliveries in the optimum location for clients, delivery information for
preferred location needs to be provided
The information for delivery can be submitted during the trading hours 3 trading
days in advance of the expiry date and up to 6 p.m. on the last day of marking
delivery intention. For example, for contracts expiring on the 20th of the month,
delivery intentions window will be open from the 18th and will close on the 20th
Clearing & Settlement of trade executed on NCDEX
Compulsory Delivery:
After the trading hours on the expiry date, based on the available
information, the delivery matching is done.
In the event of default by the seller, penalty as may be prescribed by the
Exchange from time to time would be levied. Buyer defaults are also not
permitted
Clearing & Settlement of trade executed on NCDEX
In Seller's Right contracts, delivery obligation is created for all valid sell
requests received by the Exchange.
All open positions of those sellers who fail to provide delivery intention
information for physical delivery shall be settled in cash. In case of failure
to give any delivery intention the seller is penalised
Clearing & Settlement of trade executed on NCDEX
On the expiry of the contract, all outstanding positions not resulting in
physical delivery shall be closed out at the Final Settlement Price as
announced by the Exchange. (cash settlement)
Members giving delivery requests for the Seller's right and Intention
matching contract are not permitted to square off their open positions.
Clearing & Settlement of trade executed on NCDEX
For contracts with Sellers option & Intention matching contract, the
investor has to give delivery information as prescribed by the Exchange
from time to time. If he fails to submit such information as permitted by the
Exchange, the deals have to be settled in accordance with the settlement
calendar applicable for such deals, in cash together with penalty as
stipulated by the Exchange.
For contracts having compulsory delivery, all the open positions at end of
trading hours on the expiry date of the contracts, will crystalise in to
delivery obligations and the members have to meet the obligation as per
the settlement calendar notified by the Exchange by giving or taking
delivery as the case may be, of the commodity.
In closing out, the opposite transaction is effected to close out the original
futures position.
A buy contract is closed out by a sale and a sale contract is closed out by
a buy
For e.g., an investor who took a long position in two gold futures contracts on the
January 30 at Rs.16090 per 10 grams, can close his position by selling two gold
futures contracts on February 13, at Rs.15928. In this case, over the period of
holding the position, he has suffered a loss of Rs.162 per 10 grams. This loss would
have been debited from his account over the holding period by way of MTM at the
end of each day, and finally at the price that he closes his position, that is Rs.15928,
in this case
Clearing & Settlement of trade executed on NCDEX
c) Cash Settlement
In the case of intention matching contracts, if the trader does not want to
take/ give physical delivery, all open positions held till the last day of
trading are settled in cash at the final settlement price and with penalty in
case of Sellers Right contract.
For e.g., I took a short position in five Silver 5kg futures contracts of July expiry on
June 15 at Rs.21500 per kg. At the end of 20th July, the last trading day of the
contract, he continued to hold the open position, without announcing delivery
intention. The closing spot price of silver on that day was Rs.20500 per kg. This was
the settlement price for his contract. The transaction was settled in cash and he
earned profit of Rs. 5000 per trading lot of silver