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ABCs of Commodities Trading

ABCs of Commodities Trading

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Published by RAJAN
Basics of Commodity Trading !
Basics of Commodity Trading !

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Published by: RAJAN on Dec 08, 2009
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ABCs of commodities trading
THE investment universe has, for long, consisted of stocks, bonds, fixeddeposits, mutual funds, jewellery and real estate.The lifting of the 30-year ban on commodity futures trading in India has openedyet another avenue for investors. Want to know how to go about trading incommodity futures but do not know whom to ask? Read on...
Where can I trade on commodity futures?
Commodity futures are traded in commodity exchanges and popular onlineexchanges such as the Multi Commodity Exchange (MCX), the NationalCommodity and Derivatives Exchange (NCDEX), the National Multi-CommodityExchange (NMCE) and the National Board of Trade (NBoT) in India. These areplatforms on which market participants come together to effect their trades.The NCDEX and the MCX are located in Mumbai, the NMCE in Ahmedabad andthe NBoT in Indore. These exchanges are promoted by leading banks: TheNCDEX is co-promoted by the NSE; the MCX by the SBI group; and the NMCE bythe Central Warehousing Corporation. Various stockbrokers, including Geojit,Motilal Oswal and India Infoline, provide commodity trading services. Mostbrokers take orders over the phone.
How do I initiate a trade?
 Investors are required to open a trading account with a broker or sub-broker;documents establishing address and identity proof are required. While brokersvary on the documents required for proof, most insist on a PAN card as proof of photo identity. Bank account details are also asked for enabling remittance andpayment.In the case of a company, resolution of the board authorising participation inderivatives trading would have to be produced; for firms, a copy of thepartnership deed would also be required. Those who want to give or takephysical delivery for a contract on the MCX and the NCDEX are additionallyrequired to open a demat account with NSDL or CDSL, apart from providing localsales tax registration details of the delivery centre.
What commodities can I trade in?
 The FMC (Forward Markets Commission) approves commodities that can betraded. Commodities available for trading include bullion — gold and silver;metals — steel, copper, aluminium, lead and nickel; crude; and several agricommodities. However, not all commodities are traded on all these exchanges;while crude, gold and silver are highly traded on the MCX, agri commodities aretraded more on the NMCE and the NCDEX.
What are the features of a contract in commodity futures?
 Commodity future contracts are tradeable standardised contracts, the terms andconditions of which are set in advance by the exchanges regulating the trade.The commodities are required to meet certain pre-set quality specifications; inthe case of gold, for example, on the NCDEX a minimum fineness of 0.995 and aserial number of an approved refiner.Each contract has a lot size and a delivery size, which are not the same; in thecase of gold, the lot size on the NCDEX is 100 gm while the delivery size is 1000gm. If a person wants to enter into a delivery settlement for gold, he will have toenter into a minimum of 10 contracts or multiples thereof. Market participantsare required to negotiate only the quantity and price of the contract, as all otherparameters are predetermined by the exchange.
How to settle a transaction?
A settlement takes place either through squaring off your position or by cashsettlement or physical delivery. Squaring off is taking a contrary position to theinitial stance, which means in the case of an original buy contract an investorwould have to take a sell contract.An investor who intends to give or take delivery would have to inform his brokerof the same prior to the start of delivery period.Delivery is at the option of the seller; a buyer can take delivery only in case of awilling seller. All unmatched/rejected/excess positions are cash settled; all openpositions for which no delivery information is submitted are also cash settled.Under cash settlement, the difference between the contract price and settlementprice is to be paid or received.
How do they differ from equity futures?
Unlike the stock markets that close by 3-30 p.m., the NMCE is open till 8.00p.m. and the MCX and the NCDEX until 11.00 p.m. However, only crude andmetals are traded in the night sessions. This enables the working public to placeorders from their homes.Unlike equity futures, which have a life cycle of three months, contract durationin case of commodity futures vary, and in some instances extends up to sixmonths.Market participants can hedge their position over a longer period. Commodityfutures are also easier to understand compared to equity futures, as one has to just keep track of demand and supply and not the several financial metrics thatthe latter calls for.Sales tax is applicable only when a contract results in delivery.
What margins are to be maintained?
 Investors are required to maintain margins and top up their accounts on a dailybasis — marked-to-market margin — for fluctuations based on the tick size.Margins have different components; there is an additional delivery margin thathas to be maintained once the contract enters the delivery period in case of delivery settlements.
How to give delivery?
A seller intending to give delivery would have to approach the accreditedwarehouse for availability of space and the assayer, who certifies the quality of the goods; the goods are required to meet the pre-set quality specifications.The seller has to bear storage charges until the date of demat credit,loading/unloading and all other incidental charges, including assaying charges.Not all goods can be delivered to all warehouses, as there are specific deliverycentres, which vary from commodity to commodity and from exchange toexchange. However, the seller has the option of choosing the delivery centreamong these accredited warehouses.
How to take delivery?
 A buyer intending to take physical delivery has to request his broker. The buyerhas to then approach the warehouse with the document (re-materialisation formor the warehouse receipt).It is possible to take partial delivery of the commodities from the warehouse. Allincidental charges pertaining to taking delivery are to be borne by the buyer.
Who regulates the commodity futures market?

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