Although most people might think that commodity futures are a recent concept, they have a long history in India. In 1875, a cotton futures exchange already existed. However, due to worries about speculation and stockpiling, futures in basic commodities were abandoned in the 1960s. Commodity futures were not reintroduced in India until 2002.
What are futures on commodities?
What exactly are these futures then? Let’s start by comprehending the idea of futures contracts. These are derivatives, and the value of an underlying asset determines their worth. Using a futures contract, a buyer or seller can exchange commodities at a future date and price. A wide range of items, including wheat, cotton, petroleum, gold, silver, natural gas, and others, are accessible as commodity futures.
For instance, a farmer of wheat who anticipates a crop of 100 quintals could desire to sell his goods for Rs 2,000 per quintal. The farmer is concerned that he might not be able to get the quantity he wants because wheat prices have been shifting regularly. He then enters into a futures contract to sell 100 quintals at Rs 2,000 per quintal at harvest time, one month from now, in order to protect himself from price swings. In the interim, quintal wheat prices have decreased to Rs 1,500. The farmer can, however, exercise his futures contract and receive Rs 2,000 in exchange for the fruit, making a profit of Rs 50,000. The drawback is that he won’t benefit from a price increase if wheat prices rise to Rs 2,500 because he would still have to sell the wheat for Rs 2,000. He risks losing Rs 50,000. However, producers want guaranteed prices and are prepared to forgo uncertain windfall gains in order to obtain the price they desire.
In order to protect themselves against price volatility, producers and consumers might use commodity futures. Of course, other parties are benefited in addition to producers, end users, and traders. Even if they might not have the smallest interest in the commodity itself, speculators can profit from price changes.
Countries, including major petroleum importers, participate in the trading of these futures as well. Any price adjustments have an impact on their economies. They enter into petroleum futures contracts to protect themselves from this kind of price volatility, which somewhat reduces the price risk.
Trading in commodities futures
Commodity exchanges are where commodity futures are bought and sold. The New York Mercantile Exchange (NYMEX), London Metals Exchange (LME), Chicago Mercantile Exchange (CME), and others are examples of these. On markets like the Multi-Commodity Exchange (MCE) and the National Commodity and Derivatives Exchange, these types of futures are traded in India (NCDEX).
The following are some characteristics of trading in commodities futures:
Exchanges: Commodity trading is highly organized and occurs at markets like the NYMEX in the United States and the MCX and NCDEX in India.
The contracts have a high degree of standardization. The exchanges in which they are traded govern their number, quality, price, and timing. In lots of 1 kg, 100 gm, guinea (8 gm), and petal (1 mg), for instance, gold is offered. The gold must be in bars with numbers and have a purity of 995.
Leverage: You must deposit what is referred to as an initial margin with the broker before you can trade in these futures. This represents a portion of your exposure. If your trading volume is worth Rs. 10 crore and the margin is 4 percent, your initial margin would be Rs. 40 lakh. You can buy and sell in huge quantities because the margins are quite low. Leveraging is the term for this. High leverage raises both the possibility of profit and loss. If your suspicion is correct, you might have a burst of luck. However, you lose a lot if you lose.
Commodities markets are controlled to ensure ethical conduct. The Forward Markets Commission previously oversaw trading in commodities futures in India. It was amalgamated with the Securities & Exchange Board of India, though, in 2015. (SEBI).
Physical delivery: Upon the termination of these contracts, buyers may elect to accept physical delivery. The buyer has the option to close the deal before the deal’s expiration date if they don’t want physical delivery.
The zero-sum game
It is a zero-sum game with these futures. If you succeed, someone else fails.
Benefits of trading commodities futures
Price discovery occurs as a result of trading in these futures. Prices are available, and liquidity guarantees accurate rates.
Standardized: Since these contracts are subject to regulation, it is simpler to compare pricing across international markets.
Hedging: By allowing hedging against price changes, these futures remove uncertainty for producers, traders, and end users.
Investor advantages: Investors that trade (in these futures) can diversify their portfolios, which is advantageous. For instance, investors can use gold futures to hedge their risks and safeguard their portfolios because gold prices move in the opposite direction of many other assets.
Commodity futures trading disadvantages
Leverage: It’s reasonably dangerous due to the potential large leverage. You risk losing a lot of money if you don’t get it properly.
These futures contracts have a high level of volatility. Events from all across the world have an impact on commodity markets, and price shifts can occur at any time.
Speculation: Speculators might seize control of a commodities market and drive up or drive down prices artificially.
Conclusion
Commodity futures trading has some obvious benefits. Since most commodities will remain in demand for many years to come, there are plenty of opportunities to profit. The dangers are also great. Only those who can handle a lot of risk, remain composed under pressure, and keep up with world events that can affect prices should consider a career in commodity trading. Usually, huge institutional players with extensive experience control the majority of these futures markets. However, there is no reason why small-scale investors couldn’t gain. You just need a little bit of prudence and the capacity to take in a lot of information rapidly.
