FDRM Assignment

Report Prepared By:

Group – 3
Vivek Surana
Jain Sunny Vinod
Akshay Modi
Harish kumar Parchuri
Sandeep G

COMMODITIES TRADING &

THE ROLE OF MCX
In this assignment we look into the commodities trading, role of MCX in India and futures trading
of commodities like Copper, Chana Dal & Crude Palm Oil. Hedging strategies pertaining to these
commodities have also been highlighted
 Commodities Trading and MCX

Introduction to Commodity Trading in India

Indian markets have recently thrown open a new avenue for retail investors and traders to
participate: commodity derivatives. For those who want to diversify their portfolios beyond
shares, bonds and real estate, commodities are the best option.

Till some months ago, this wouldn't have made sense. For retail investors could have done
very little to actually invest in commodities such as gold and silver -- or oilseeds in the
futures market. This was nearly impossible in commodities except for gold and silver as there
was practically no retail avenue for punting in commodities.

However, with the setting up of three multi-commodity exchanges in the country, retail
investors can now trade in commodity futures without having physical stocks!

Commodities actually offer immense potential to become a separate asset class for market-
savvy investors, arbitrageurs and speculators. Retail investors, who claim to understand the
equity markets may find commodities an unfathomable market. But commodities are easy to
understand as far as fundamentals of demand and supply are concerned. Retail investors
should understand the risks and advantages of trading in commodities futures before taking a
leap. Historically, pricing in commodities futures has been less volatile compared with equity
and bonds, thus providing an efficient portfolio diversification option.

In fact, the size of the commodities markets in India is also quite significant. Of the country's
GDP of Rs 13,20,730 crore (Rs 13,207.3 billion), commodities related (and dependent)
industries constitute about 58 per cent.

Currently, the various commodities across the country clock an annual turnover of Rs
1,40,000 crore (Rs 1,400 billion). With the introduction of futures trading, the size of the
commodities market grow many folds here on.

Like any other market, the one for commodity futures plays a valuable role in information
pooling and risk sharing. The market mediates between buyers and sellers of commodities,
and facilitates decisions related to storage and consumption of commodities. In the process,
they make the underlying market more liquid.

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 Commodities Trading and MCX

Commodity Trading Exchanges

Three exchanges are available for commodities trading in India –

 National Commodity and Derivative Exchange (NCDEX)

 Multi Commodity Exchange of India Ltd (MCX)
 National Multi Commodity Exchange of India Ltd.

All three have electronic trading and settlement systems and a national presence.

Minimum Investment Requirements

One can have an amount as low as Rs 5,000. All one needs is money for margins payable
upfront to exchanges through brokers. The margins range from 5-10 per cent of the value of
the commodity contract. While one can start off trading at Rs 5,000 with ISJ Commtrade
other brokers have different packages for clients.

For trading in bullion, that is, gold and silver, the minimum amount required is Rs 650 and Rs
950 for on the current price of approximately Rs 65,00 for gold for one trading unit (10 gm)
and about Rs 9,500 for silver (one kg).

The prices and trading lots in agricultural commodities vary from exchange to exchange (in
kg, quintals or tonnes), but again the minimum funds required to begin will be approximately
Rs 5,000.

Settlement Basis

All the exchanges have both systems - cash and delivery mechanisms. The choice is
investor’s. If an investor wants his/her contract to be cash settled, he/she shall have to
indicate at the time of placing the order that he/she don't intend to deliver the item.

If an investor plans to take or make delivery, he/she needs to have the required warehouse
receipts. The option to settle in cash or through delivery can be changed as many times as one
wants till the last day of the expiry of the contract.

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 Commodities Trading and MCX

Basic Requirements for Commodity Trading

An investor will need only one bank account. He/she will need a separate commodity demat
account from the National Securities Depository Ltd. to trade on the NCDEX just like in
stocks

Investor will have to enter into a normal account agreements with the broker. These include
the procedure of the Know Your Client format that exist in equity trading and terms of
conditions of the exchanges and broker. Besides one will need to give other details such as
PAN no., bank account no, etc.

Brokerage and other Charges

The brokerage charges range from 0.10-0.25 per cent of the contract value. Transaction
charges range between Rs 6 and Rs 10 per lakh/per contract. The brokerage will be different
for different commodities. It will also differ based on trading transactions and delivery
transactions. In case of a contract resulting in delivery, the brokerage can be 0.25 - 1 per cent
of the contract value. The brokerage cannot exceed the maximum limit specified by the
exchanges.

Regulators for Commodity Trading

The exchanges are regulated by the Forward Markets Commission. Unlike the equity
markets, brokers don't need to register themselves with the regulator.

The FMC deals with exchange administration and will seek to inspect the books of brokers
only if foul practices are suspected or if the exchanges themselves fail to take action. In a
sense, therefore, the commodity exchanges are more self-regulating than stock exchanges.
But this could change if retail participation in commodities grows substantially.

Players in Commodity Derivatives

The commodities market will have three broad categories of market participants apart from
brokers and the exchange administration - hedgers, speculators and arbitrageurs. Brokers will
intermediate, facilitating hedgers and speculators.

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 Commodities Trading and MCX

Hedgers are essentially players with an underlying risk in a commodity - they may be either
producers or consumers who want to transfer the price-risk onto the market.

Producer-hedgers are those who want to mitigate the risk of prices declining by the time they
actually produce their commodity for sale in the market; consumer hedgers would want to do
the opposite.

For example, if you are a jewellery company with export orders at fixed prices, you might
want to buy gold futures to lock into current prices. Investors and traders wanting to benefit
or profit from price variations are essentially speculators. They serve as counterparties to
hedgers and accept the risk offered by the hedgers in a bid to gain from favourable price
changes.

Tradable Commodities

Though the government has essentially made almost all commodities eligible for futures
trading, the nationwide exchanges have earmarked only a select few for starters. While the
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.

Default Mechanisms

Both the exchanges, NCDEX and MCX, maintain settlement guarantee funds. The exchanges
have a penalty clause in case of any default by any member. There is also a separate
arbitration panel of exchanges.

Margins in Commodity Trading

As in stocks, in commodities also the margin is calculated by (value at risk) VaR system.
Normally it is between 5 per cent and 10 per cent of the contract value.

The margin is different for each commodity. Just like in equities, in commodities also there is
a system of initial margin and mark-to-market margin. The margin keeps changing depending
on the change in price and volatility.

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 Commodities Trading and MCX

In case of delivery, the margin during the delivery period increases to 20-25 per cent of the
contract value. The member/ broker will levy extra charges in case of trades resulting in
delivery.

Circuit Filters

The exchanges have circuit filters in place. The filters vary from commodity to commodity
but the maximum individual commodity circuit filter is 6 per cent. The price of any
commodity that fluctuates either way beyond its limit will immediately call for circuit
breaker.

Multi Commodity Exchange of India Ltd. (MCX)

Headquartered in Mumbai, Multi Commodity Exchange of India Ltd (MCX) is a state-of-the-

art electronic commodity futures exchange. The demutualised Exchange set up by Financial
Technologies (India) Ltd (FTIL) has permanent recognition from the Government of India to
facilitate online trading, and clearing and settlement operations for commodity futures across
the country. 

Having started operations in November 2003, today, MCX holds a market share of over 80%
of the Indian commodity futures market, and has more than 2000 registered members
operating through over 100,000 trader work stations, across India. The Exchange has also
emerged as the sixth largest and amongst the fastest growing commodity futures exchange in
the world, in terms of the number of contracts traded in 2009. 

MCX offers more than 40 commodities across various segments such as bullion, ferrous and
non-ferrous metals, and a number of agri-commodities on its platform. The Exchange is the
world's largest exchange in Silver, the second largest in Gold, Copper and Natural Gas and
the third largest in Crude Oil futures, with respect to the number of futures contracts traded.

MCX has been certified to three ISO standards including ISO 9001:2000 Quality
Management System standard, ISO 14001:2004 Environmental Management System
standard and ISO 27001:2005 Information Security Management System standard. The
Exchange’s platform enables anonymous trades, leading to efficient price discovery.

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 Commodities Trading and MCX

Moreover, for globally-traded commodities, MCX’s platform enables domestic participants

to trade in Indian currency.
The Exchange strives to be at the forefront of developments in the commodities futures
industry and has forged strategic alliances with various leading International Exchanges,
including Euronext-LIFFE, London Metal Exchange (LME), New York Mercantile
Exchange, Shanghai Futures Exchange (SHFE), Sydney Futures Exchange, The Agricultural
Futures Exchange of Thailand (AFET), among others. For MCX, staying connected to the
grassroots is imperative. Its domestic alliances aid in improving ethical standards and
providing services and facilities for overall improvement of the commodity futures market.

Key Shareholders

Promoted by FTIL, MCX enjoys the confidence of blue chips in the Indian and international
financial sectors. MCX's broad-based strategic equity partners include:

 NYSE Euronext
 State Bank of India and its associates (SBI)
 National Bank for Agriculture and Rural Development (NABARD)
 National Stock Exchange of India Ltd (NSE)
 SBI Life Insurance Co Ltd.
 Bank of India (BOI)
 Bank of Baroda (BOB)
 Union Bank of India
 Corporation Bank
 Canara Bank
 HDFC Bank
 Fid Fund (Mauritius) Ltd. - an affiliate of Fidelity International
 ICICI Ventures
 IL&FS
 Kotak Group
 Citi Group
 Merrill Lynch

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 Commodities Trading and MCX

Commodities Available for Trade on MCX

Copper

Copper ranks third in world metal consumption after steel and aluminium. It is the best non-
precious metal conductor of electricity. Copper is an essential component of energy efficient
motors, transformers and automobiles. It is also used in power cables for high, medium and
low voltage applications.

Land-based resources of copper are estimated at 1.6 billion tons and 0.7 billion tons in deep-
sea nodules. The global production of refined copper is around 15 million tons. The major
consumers are Western Europe (28.5%), the United States (19.1%), Japan (14%), and China
(5.3%). The size of Indian Copper Industry is 4 lakh tons, which as percentage of world
copper market is 3 %.

Birla Copper, Sterilite Industries and Hindustan Copper are the three major producers of
copper. India is emerging as net exporter of copper from the status of net importer. Copper
goes into various usage such as Building, Cabling for power and telecommunications,
Automobiles etc.

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 Commodities Trading and MCX

Factors Influencing Copper Markets

• LME and NYMEX provide direction to the copper prices

• Prices in India are fixed on the basis of the rates that rule on LME the preceding day

• Economic growth of the major consuming countries

• Growth and development in the Building, electronics and electrical industry

Copper Futures Contract Specifications as traded on MCX

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 Commodities Trading and MCX

Trading Data of Copper Futures on the MCX

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 Commodities Trading and MCX

Chana Dal

Chana belongs to leguminasae family and there are two main types - Desi and Kabuli. Desi
chickpeas is the main type grown in India. India's production fluctuates between 4-7 million
tons. 40% of India's total pulse production. The major producing states are Madhya Pradesh
(1.5-2.5 million tons, Uttar Pradesh (0.7-0.85 million tons), Rajasthan (0.5-2.5 million tons)
and Maharashtra (0.5-0.7 MT)

India accounts for 2/3rd of the world's chickpea production. India imports around 3-4 lakh
tons of chickpeas annually. India imports chickpeas from Canada, Australia, Iran and
Myanmar. Indian chana markets are highly fragmented, with very long value chain. The
information flow between these participants is restricted and very slow.

Factors Influencing Chana Dal Markets

• Climatic Conditions

• Sentiment of Traders

• Black marketing and hoarding

• Situation of crop in exporting countries to India

• Prices of other major pulses

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 Commodities Trading and MCX

Chana Dal Futures Contract Specifications as traded on MCX

Trading Data of Chana Dal Futures on the MCX

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 Commodities Trading and MCX

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 Commodities Trading and MCX

Crude Palm Oil

Palm oil is second most produced oil in the world. Malaysia (13 million tons) and Indonesia
(10 million tons) are the major producers. Both Malaysia and Indonesia together account for
85% of production of palm oil in the world. India, China and EU are the major importers.
Price competitiveness has been reason for increased consumption of this oil.

India imports roughly 2.5-3.5 million tons of palm oil and its variants a year. India imposes
65% duty on crude oil and 75% on RBD Palm oil. In addition to the customs duty,
Government of India also imposes tariff value. Kandla, Mumbai, Kakinada are the major
ports for palm oil entry to India and are the major trading points as well.

Factors Influencing Crude Palm Oil Markets

• Bursa Malaysian Derivatives (BMD) is the largest futures market for crude palm oil.

• Malaysian & Indonesian FOB prices set the mood in the physical market.

• The supply-demand scenario of all oils and oilseeds in the consuming centers.

• The palmoil production cycle: April - December is peak production period.

• Import regulations imposed in the importing countries.

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 Commodities Trading and MCX

Crude palm Oil Futures Contract Specifications as traded on MCX

Trading Data of Chana Dal Futures on the MCX

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 Commodities Trading and MCX

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 Commodities Trading and MCX

Hedging Strategies

COPPER

Suppose we need to procure 50 tonnes of copper in 6 months' time. The prevailing spot price
for copper is USD 10133/ton while the price of copper futures for delivery in 6 months' time
is USD 9500/ton. To hedge against a decrease in copper price, we decide to lock in a future
purchase price of USD 9500/ton by taking a long position in an appropriate number of LME
Copper 'A' Grade futures contracts. With each LME Copper 'A' Grade futures contract
covering 1 tonnes of copper, we would require to go long 50 futures contracts to implement
the hedge.

The effect of putting in place the hedge should guarantee that we will be able to purchase the
50 tonnes of copper at USD 9500/ton for a total amount of USD 475000. Let's see how this is
achieved by looking at scenarios in which the price of copper makes a significant move either
upwards or downwards by delivery date.

Scenario 1: Copper Spot Price Rose by 10% to USD 11146/ton on Delivery Date

With the increase in copper price to USD 11146/ton, we will now have to pay USD 557300
for the 50 tonnes of copper. However, the increased purchase price will be offset by the gains
in the futures market.

By delivery date, the copper futures price will have converged with the copper spot price and
will be equal to USD 11146/ton. As the long futures position was entered at a lower price of
USD 9500/ton, it will have gained USD 11146 - USD 9500 = USD 1646 per tonne. With 50
contracts covering a total of 50 tonnes of copper, the total gain from the long futures position
is USD 82300.

In the end, the higher purchase price is offset by the gain in the copper futures market,
resulting in a net payment amount of USD 557300 - USD 82300 = USD 475000. This
amount is equivalent to the amount payable when buying the 2,500 tonnes of copper at USD
9500/ton.

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 Commodities Trading and MCX

Scenario 2: Copper Spot Price Fall by 10% to USD 9120/ton on Delivery Date

With the spot price having fallen to USD 9120/ton, we need to pay USD 456000 for the
copper. However, the loss in the futures market will offset any savings made.

Again, by delivery date, the copper futures price will have converged with the copper spot
price and will be equal to USD 9120/ton. As the long futures position was entered at USD
9500/ton, it will have lost USD 9500 - USD 9120 = USD 380 per tonne. With 50 contracts
covering a total of 50 tonnes, the total loss from the long futures position is USD 19000

Ultimately, the savings realised from the reduced purchase price for the commodity will be
offset by the loss in the copper futures market and the net amount payable will be USD
456000 + USD 19000 = USD 475000. Once again, this amount is equivalent to buying 50
tonnes of copper at USD 9500/ton.

Risk/Reward Tradeoff

As you can see from the above examples, the downside of the long hedge is that the copper
buyer would have been better off without the hedge if the price of the commodity fell.

An alternative way of hedging against rising copper prices while still be able to benefit from
a fall in copper price is to buy copper call options.

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 Commodities Trading and MCX

CHANNA DAL

Suppose we need to procure 500 MT of Chana Dal in 2 months' time. The prevailing spot
price for chana dal is USD 510/ton while the price of chana dal futures for delivery in 2
months' time is USD 550/ton. To hedge against a rise in chana dal price, we decide to lock in
a future purchase price of USD 550/ton by taking a long position in an appropriate number of
LME Chana dal 'A' Grade futures contracts. With each MCX Chana dal 'A' Grade futures
contract covering 10MT of chana dal, we would require to go long 50 futures contracts to
implement the hedge.

The effect of putting in place the hedge should guarantee that we will be able to purchase the
500MT of chana dal at USD 550/ton for a total amount of USD 275000. Let's see how this is
achieved by looking at scenarios in which the price of chana dal makes a significant move
either upwards or downwards by delivery date.

Scenario 1: Chana dal Spot Price Rose by 10% to USD 561/ton on Delivery Date

With the increase in chana dal price to USD 561/ton, we will now have to pay USD 280500
for the 500MT of chana dal. However, the increased purchase price will be offset by the gains
in the futures market.

By delivery date, the chana dal futures price will have converged with the chana dal spot
price and will be equal to USD 561/ton. As the long futures position was entered at a lower
price of USD 550/ton, it will have gained USD 561 - USD 550 = USD 11 per tonne. With 50
contracts covering a total of 500 MT of chana dal, the total gain from the long futures
position is USD 5500.

In the end, the higher purchase price is offset by the gain in the chana dal futures market,
resulting in a net payment amount of USD 280500 - USD 5500 = USD 275000. This amount
is equivalent to the amount payable when buying the 500 MT of chana dal at USD 550/ton.

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Scenario 2: Chana dal Spot Price Fall by 10% to USD 459/ton on Delivery Date

With the spot price having fallen to USD 459/ton, we need to pay USD 229500 for the chana
dal. However, the loss in the futures market will offset any savings made.

Again, by delivery date, the chana dal futures price will have converged with the chana dal
spot price and will be equal to USD 459/ton. As the long futures position was entered at USD
550/ton, it will have lost USD 550 - USD 459 = USD 91 per tonne. With 50 contracts
covering a total of 500 MT, the total loss from the long futures position is USD 45500

Ultimately, the savings realised from the reduced purchase price for the commodity will be
offset by the loss in the chana dal futures market and the net amount payable will be USD
229500+ USD 45500 = USD 275000. Once again, this amount is equivalent to buying 500
MT of chana dal at USD 550/ton.

NOTE: It is likely that the price of Chana dal will move downwards as the number of
contracts is decreasing. The futures contract has reduced by 82% in 2010 resulting into
low demand for the commodity; also the number of contracts traded in the last few
months is less as compared to the same period of the previous year. Hence if the price go
down in future then the strategy is as follows:-

1) Take a short position in the commodity market at the current price of USD 550/ton
2) Enter into a long position in the commodity future market price of USD 459/ton

Hence at the maturity of the contract the profit made is USD 91/ton.

Risk/Reward Tradeoff

As you can see from the above examples, the downside of the long hedge is that the chana dal
buyer would have been better off without the hedge if the price of the commodity fell.

An alternative way of hedging against rising chana dal prices while still be able to benefit
from a fall in chana dal price is to buy chana dal call options.
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 Commodities Trading and MCX

CRUDE PALM OIL

Suppose we need to procure 500 MT of Crude Palm Oil in 1 months' time (50 contracts). The
prevailing spot price for Crude Palm Oil is USD1233/ton while the price of Crude Palm Oil
futures for delivery in 1 months' time is USD 1267/ton. To hedge against a rise in Crude
Palm Oil price, we decide to lock in a future purchase price of USD1267/ton by taking a long
position in an appropriate number of MCX Crude Palm Oil 'A' Grade futures contracts. With
each LME Crude Palm Oil 'A' Grade futures contract covering 10 MT of Crude Palm Oil, we
would require to go long 50 futures contracts to implement the hedge.

The effect of putting in place the hedge should guarantee that we will be able to purchase the
500 MT of Crude Palm Oil at USD 1267/ton for a total amount of USD 633500. Let's see
how this is achieved by looking at scenarios in which the price of Crude Palm Oil makes a
significant move either upwards or downwards by delivery date.

Scenario 1: Crude Palm Oil Spot Price Rose by 10% to USD 1356/ton on Delivery Date

With the increase in Crude Palm Oil price to USD 1356/ton, we will now have to pay USD
678000 for the 500 MT of Crude Palm Oil. However, the increased purchase price will be
offset by the gains in the futures market.

By delivery date, the Crude Palm Oil futures price will have converged with the Crude Palm
Oil spot price and will be equal to USD 1356/ton. As the long futures position was entered at
a lower price of USD 1267/ton, it will have gained USD 1356 - USD 1267 = USD 89 per
tonne. With 50 contracts covering a total of 500 MT of Crude Palm Oil, the total gain from
the long futures position is USD 44500

In the end, the higher purchase price is offset by the gain in the Crude Palm Oil futures
market, resulting in a net payment amount of USD 678000 - USD 44500 = USD 633500.
This amount is equivalent to the amount payable when buying the 500 tonnes of copper at
USD 1267/ton.

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Scenario 2: Crude Palm Oil Spot Price Fall by 10% to USD 1110/ton on Delivery Date

With the spot price having fallen to USD 1110/ton, we need to pay USD 555000 for the
Crude Palm Oil. However, the loss in the futures market will offset any savings made.

Again, by delivery date, the Crude Palm Oil futures price will have converged with the Crude
Palm Oil spot price and will be equal to USD 1110/ton. As the long futures position was
entered at USD 1267/ton, it will have lost USD 1110 - USD 1267 = USD 157 per tonne. With
50 contracts covering a total of 500 MT, the total loss from the long futures position is USD
78500

Ultimately, the savings realised from the reduced purchase price for the commodity will be
offset by the loss in the Crude Palm Oil futures market and the net amount payable will be
USD 555000 + USD78500 = USD 633500. Once again, this amount is equivalent to buying
500 MT of Crude Palm Oil at USD 1267/ton.

Risk/Reward Tradeoff

As you can see from the above examples, the downside of the long hedge is that the Crude
Palm Oil buyer would have been better off without the hedge if the price of the commodity
fell.

An alternative way of hedging against rising Crude Palm Oil prices while still be able to
benefit from a fall in Crude Palm Oil price is to buy Crude Palm Oil call options.

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