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Abstract: Financial derivatives, futures and options, have emerged as widely traded instruments around the world, including emerging markets. Commodity futures form a small part of that trading but have important hedging implications for agricultural producers and consumers. In India, trading in futures was banned for decades before it was again made legal in mid-90s. Since then commodity futures trading is conducted in over 25 exchanges, with four major multi-commodity exchanges set to dominate trading in the future. The exchanges vary in their contract specifications and settlement rules. Keeping pace with the rest of the world, Indian futures exchanges are also increasingly taking to the Electronic Communication Network (ECN) framework for trading.
Commodity Futures in India 1. Background – Commodities derivative trading around the world
Financial markets help transfer risk from some agents to other. One is hard pressed to think of a business venture more risk-prone than agriculture. The quantity of the produce is uncertain and so is the price. Throughout the life of a crop, therefore, the growers as well as the potential customers have to make decisions that are inherently risky given the uncertainty associated with agriculture. It is hardly a surprise then, that commodity futures have been among the earliest derivatives thought of by man and the daily trading volume of agricultural commodity futures worldwide runs into several billion dollars. Futures and options constitute the most active derivatives trading markets round the world. The volume of future contracts traded around the globe in the first half of 2003 was 1,436.1 million contracts, up over 36% from the corresponding figure a year ago. Out of this, slightly over 5% (which is still a whopping 75 million contracts) consisted of agricultural commodities. This recorded a rise of slightly over 25% over its previous year’s figure1. Figure 1 shows trading volume in the most active futures markets in the world. Eurex, the European electronic exchange connecting over 700 centers around the world is clearly the leader, dealing exclusively in financial futures. [Figure 1 about here] The idea of trading futures may be traced to forward contracts as far as back to around 2000 BC in China. In essence, a future is a contract to deliver a specified amount of a certain commodity at a particular date for a specified price. Box 1 explains the fundamentals of a future contract. A forerunner and close relative of the future contract was the forward contract. The differences between forward and future contracts are explained in Box 2 below. [Box 1 about here] [Box 2 about here] The beginnings of the modern worldwide futures markets can be traced to Chicago, that had emerged as an important agricultural commodity trading center in the early 1800s. In 1848, eleven years after Chicago became a city, the Chicago Board of Trade (CBOT) was founded as a commodity exchange. Forward contracts where traded along with “spot” commodities in the beginning years, but their lack of standardization was soon proving to be a hindrance to their liquidity and trading. So in 1865, the CBOT came up with a futures contract that standardized quality, quantity and other features of the forward contracts. The futures market received a major boost over a century later, in the early 1970’s, not from any major innovation in the agricultural/commodity sector but because of the increased volatility in exchange rates as the Bretton Woods system broke down and in interest rates during the rocky 1970s. As risk in financial markets increased, there was an acute need for hedging instruments and a panoply of financial futures were designed and started trading heavily in the USA as well as in other developed countries. Though commodity futures, which lie at the root of the development of the futures market worldwide, may have been created primarily out of the hedging needs of the
Futures Industry (www.futuresindustry.org)
agricultural prices varied greatly across the country with some parts of the nation burdened with excess supply of the same produce that was in severe need in some other parts. with the regional markets. the exact mechanism of hedging with futures does not even necessitate delivering on the futures contract. Box 4 explains how this works. agriculture’s importance to the Indian economy can hardly be exaggerated. 2 . because of a feature of the futures markets known as marking to market that changes the settlement price on the futures contract being traded every day. [Box 4 about here] Speculative trading in futures markets have received a boost in recent years with managed funds focusing specifically on futures contracts. reduced the information problem and set the stage for establishment of national-level commodity markets in India. speculation has its risks in the futures markets as well and given its high leverage a wrong bet has the potential of having devastating effect on the speculators’ fortune. [Box 3 about here] The most important economic function that agricultural commodity futures markets serve is that it enables farmers as well as buyers to hedge price risk. working pretty much in isolation from one another. This is because the nature of future trading lends itself easily to speculative motives and allows speculators. agricultural prices in India continue to be volatile and the output heavily dependent on weather conditions. The telecommunication revolution that swept through the country in the 90’s. Commodity trading has traditionally been dispersed and fragmented across the country with regional commodity markets and local mandis accounting for all trading. Commodity futures markets in India Accounting of a quarter of the nation’s GDP and providing employment to about two-thirds of its labour force. In other words. over 95% of the trading volume in futures comprise speculative trades. The reason for this is not difficult to find. future markets allow for highly leveraged trading. till recently there was no large nation-wide commodity market. Box 3 explains how marking to market works and why it is important to the smooth functioning of the futures markets. Interestingly enough. the distributional benefits of a market system remained untapped because of such fragmented trading in agricultural produce. Like in any other market. Also. including the advent of the Internet. Market fragmentation paved the way for acute foodgrain shortages and poverty among the growers of the same crops to exist simultaneously. The physical encumbrances to storing and moving bulky and perishable agricultural commodities persist and their removal would lead to a strengthening of the national markets. [Box 5 about here] 2. Clearly.buyers and sellers. In spite of the critical importance of agriculture in India. who are willing to take on risks in expectation of profits. however. agriculture continues to be a risky occupation in India. Physical warehousing and transportation problems as well as information problems hindered the development of a national market. take on large positions for very little investment. In spite of the role of government agencies to act as a buffer and help stabilize market prices. As a result. compared to many other activities.
In late 2003. 2003 (www. This overly regulated nature of the economy did not bode well for the development of these markets.rediff. jute products and castor seed as well as precious metals. has been working at the promotion of futures trading. Since its establishment in 1995.com/money/2003/nov/19commodity. futures were being traded on commodities like wheat. In 1966 futures trade was altogether banned to give effective powers of governmental price control. as well as commodity futures.com. Price control was also a central feature of economic policy during much of this period. set up within the Ministry of Consumer Affairs. rice. Its efforts included the reforming and strengthening the existing commodity exchanges. the commodity futures market has the potential to grow to a $600 billion market. Futures contracts were viewed as a subset of standardized forward contracts and were never formally defined in the Act. The Forward Markets Commission which oversees forward trading was instituted a regulatory body the following year. They have been granted the “nation-wide multi-commodity” status and they “Commodity futures $600 bn market: Ambani”.Commodity derivatives are not exactly new to India. the four national level commodity exchanges are the most important. Ambani. the National Agricultural Policy 2000 envisioned the removal of price controls in agricultural markets and widespread use of futures contracts. [Table 1 about here] Of these exchanges. The Act applied to all contracts whereby the delivery of goods occurs after a period longer than 11 days. believe that with a booming futures market. including Reliance chairman Mukesh Ambani. the separate Department of Consumer Affairs. Regulators viewed markets in general with suspicion and derivatives markets as the terrain of unscrupulous speculation. According to Mr. Rediff.2 In recent years. the Forward Contracts (Regulation) Act was enacted in 1952 to regulate the trading in forward and futures trading. sugar. The task of the Commission is to monitor and regulate the trading of forward contracts since manipulation in these markets are likely to create severe imbalances with adverse welfare effects. several derivatives exchanges have sprouted across the country facilitating trading in agricultural commodities. just a decade after CBOT traded its first future. Many. In 1993 the Kabra committee was appointed to look into forward markets. Oilseed and food grain futures followed and before the Second World War. Nevertheless. During World War II futures trading was prohibited to contain runaway speculation and illegal hoarding. All that began to change with the liberalization of the Indian economy in the early 1990’s. After independence. The committee recommended in 1994 that all futures banned in 1966 be reintroduced as well as many others added. Table 1 provides a list of exchanges where commodity futures are traded. groundnut. raw jute.htm) 2 3 . Food and Public Distribution. 19. Indian markets did not really blossom over the following four decades. the physical agricultural spot market could grow ten-fold. groundnut oil. In fact forward trading in commodities existed in India from ancient times (it is mentioned in Kautilya’s Arthashastra) and the first modern futures market was established in 1875 for cotton contracts by the Bombay Cotton Trade Association. Nov. the agricultural commodities market was estimated at $ 30 billion. Six years later. A few select commodities saw a reintroduction of futures in 1980 following the Khusro committee report.
obviously. If a seller delivers a product that falls below the acceptable quality or quantity ranges. Ahmedabad (NMCE) shown in Table 4. Its acceptable quantity variation is larger than that for soybean and its unit of trading is ten times that of the soybean contract at the same exchange. Individual and broker position limits prevent market manipulation by a single buyer or broker. The place for delivery is different as well (Muzaffarnagar. Of late. there is a distinct move towards “de-materialization” or online electronic 4 . through an “open outcry” system. [Table 5 about here] Trading Systems in Exchanges: Till recently. The standardized unit of trading and delivery eases price quoting and facilitates trading. Quite a few differences in the specifications immediately catch our attention. the National Multi-Commodity Exchange. The NMCE contract. [Table 3 about here] As is evident from table 3. however. [Table 2 about here] 3. a sugar contract from the NCDEX (Table 5). Mumbai (NCDEX) shown in table 3. The exact design of a contract is driven by the rules and bye-laws of the exchange where it is traded. according to commodities as well. Let us consider. Delhi and Kolkata as opposed to Indore for soy bean). The tick size and price bands address market microstructural issues and prevent excessive price volatility and market manipulation. Specification of the different quality parameters is essential in the case of commodities when the underlying asset is inherently heterogeneous. all trading in commodity futures took place just the way the physical commodities themselves have always traded. for instance. Contracts vary.are rapidly emerging as the major centers of commodity futures trading. The tick size is larger and the price band more stringent. the soy bean futures contract on the National Commodities and Derivatives Exchange. [Table 4 about here] Now compare this contract with a soybean futures contract from another national futures exchange. Table 3 also tells us the calendar for trading of contracts and specifies the number of contracts that are active at a point in time. Several other elements mentioned in the contract relate to the trading rules for the specific contracts in the relevant exchange. the buyer can refuse the delivery as settlement of the contract. The contract also specifies the range of variation in quantity that can be within the acceptable range. the futures contract specifies several aspects of the contract. A Glimpse of future trading in India The Futures Contract: Commodity futures contracts vary depending upon the exchange and the commodity in question. Delivery centers are specified as well to take into account possible issues with transportation costs. Consider. for instance. Some of their features are described in table 2 below. for instance trades under quite different trading rules compared to that at NCDEX.
However. A warehousing receipt is a receipt issued by a government recognized warehouse. for instance. Apart from the trading that goes on in the exchanges. The actual delivery almost always takes the form of warehousing receipts. however. supplemented by independent public representatives. trading takes place primarily through an open outcry system. The brokerage varies from commodity to commodity and is below maximum limits set by the relevant exchange. 5. the sellers and buyers have to notify the exchange whether they want to deliver/take delivery on the contract or “square it off” on maturity. Margins in India typically fall in the 5-10% range and one can start trading in commodities with as low a balance as Rs. many exchanges have their internal clearing houses. Presently. certifying that a certain quantity of an agricultural commodity is kept in storage there. i. that a relatively small fraction of the futures traded actually come up for delivery – most are “squared off” before maturity. there are recommendations (as. Clearinghouses associated with the different futures exchanges play a crucial role in the futures market. settlement and delivery of contracts etc. Brokerage charges usually range from 0.10-0. The receipt itself is negotiable and is acceptable as settlement of claims. In addition there are brokerage and other fees. have external promoters and shareholders. They are managed by a board of directors comprising largely the members of the trading association. A complex and potentially problematic part of futures trading is the settlement of futures contracts. It must be borne in mind.trading. trading in the gray market may account for as much as 25-30% of the total futures trading in India. Most regional exchanges still retain that form of organizational structure. there is a significant gray market outside the exchanges where futures change hands. The organization and governance of futures exchanges: In India futures exchanges.25 per cent of the contract value and generally higher for a contract resulting in delivery. like other financial exchanges have been traditionally run as self-regulating associations of traders and brokers under the overall guidance of the Forward Market Commission rules and regulations. There are also transaction charges of approximately Rs 6 to Rs 10 per contract. Usually about a week before the maturity of the futures contract. The four national-level exchanges. This is also reflected in their board composition. the exchanges have different committees to look into the various functions like floor trading. They take the counter-party position in futures contracts thus guaranteeing against the counter-party default risk. with the majority stake often coming from public sector financial institutions. The board appoints a management team that runs the day-to-day affairs of the exchange. In most of the other regional exchanges. According to some estimates. Three of the four major national-level exchanges use screen-based electronic trading and the oldest (NBOT) is moving towards it as well. For those sellers who intend to deliver on their contracts exchanges follow more or less the same system. The exchange then matches up the buyers and sellers intending on making delivery.000. pay/accept cash. In most cases.e. setting of settlement price for the day. in the World Bank report of Frida Youssef (2000)) to set up a National level clearing house facility whose services could be availed by all futures exchanges. 5 .
[Box 6 about here] An already observable shift is occurring in the ownership structure and corporate governance of exchanges. Global trends in future markets and the road ahead for India As the futures market emerge and bloom in India. The ECN-type organization of futures markets is likely to be the next step as trading moves away from open outcry trading floors to screen-based trading. Perhaps the biggest event in financial markets around the world – not just commodities or futures markets but securities markets as well – in recent years has been the emergence of Electronic Communication Networks (ECNs). 6 . we should expect to see important changes in the existing regional exchanges. There are however. In other words. an important question will arise about the viability and future of the several regional. speed of price discovery are all undergoing major changes and Indian markets have to rapidly adjust themselves to these changes. be a positive development for all concerned.4. Exchange brokers. financial markets all over the world are being rapidly transformed by the Internet revolution. Perhaps an electronic limit order book is the unavoidable destiny of all trading be it in equities or in futures. Also with the continued acceptance and popularity of institutionalized commodity futures trading. provide guarantee for the transactions. issues about standards that need to be tackled before the commodity futures markets become more integrated. often single-commodity stand-alone exchanges in operation. Commodity exchanges. Box 6 explains the nature and benefits of ECNs. probably the bulk of informal futures trading will slowly be absorbed in the regulated. There is therefore a distinct possibility of integration in terms of exchanges. There are however issues with opening the doors of an exchange of the general public without the intermediation of exchange “member” brokers. so clearly. As the multi-commodity national-level commodity exchanges become important and gain volume. through-exchange trading as the price and liquidity benefits outweigh the added transaction costs. Improved corporate governance is essential for the development of commodity futures trading in India and perhaps the first and most important step in that direction is to separate the ownership and management of exchanges from the participating brokers. with sizeable deposits with the exchange. This raised several transparency and governance issues for exchanges and increased the possibility of price manipulations and unethical practices that Indian markets are so notorious for. like their equity counterparts used to b owned and run by associations of brokers. Alternative mechanisms need to be brought in place for honoring contracts if the ECN model is to be adopted in India. That would. some of the local exchanges will probably lose out or become associated with one or more national-level exchanges. organization of trading. indeed. they would have to improve their technology. trades are likely to converge to exchanges that attract the most players and offer most liquidity. the “selfregulating” model is likely to give way to for-profit exchanges promoted by outside agencies and financial institutions and run by a team of professionals. Till the integration happens. Faced with competition from nation-wide exchanges. transparency and methods of operation in the short run if they are serious about staying in business. After all. Participation level of individuals.
hopefully that will change soon as the futures rise in popularity and stature. With the increasing role of multi-national corporations in the agricultural and food processing as well as international trade. its effects are likely to become visible in the commodities futures markets as well. which are now being offered in India as bank products but not actively traded in the bourses. These are the weather derivatives. Its rise offers participants in Indian agriculture a much needed way to hedge their risks. small and medium farmers and farmer cooperatives are still hard to find amidst the users of futures markets. Malaysia. In the global scenario. It is likely that Indian exchanges would also form partnerships with foreign exchanges allowing more sophisticated instruments enabling Indian traders to better hedge their international risks. Over time. It is reasonable. Matif and SIMEX and the CBOT/Eurex alliances have futures exchanges worldwide as partners. There is also an increasing need for participating clients to hedge and speculate on Indian commodity prices in relation to world prices rather than in isolation.As the Indian economy and financial markets become increasingly integrated with the global markets. Then they would truly make a difference where it matters most. Even now. the connection between commodity prices in India and world prices are becoming increasingly linked. then. technology and contract specifications. the linkage between Indian commodity prices and futures prices will be even more connected with world prices and possibly trading itself would be international. While as of now. In about a decade’s time. 7 . new products are likely to be introduced in the Indian futures markets. The Globex Alliance led by CME. to expect that with time. most opening trades in commodities markets take their price cue from the commodities markets at Kuala Lampur. A category of futures that have are extremely popular in developed countries will perhaps make their appearance in India too. there has been an emergence of alliances of futures markets. If properly designed such futures can help farmers hedge the climate and rainfall related risks that are concomitant with Indian agriculture. commodity futures in India have come a long way from the domain of barely legal bets to trading on multi-commodity national level exchanges with sophisticated products.
The seller (or writer) of a future contract thus promises to deliver the quantity of the commodity traded on the expiration date while the buyer promises to buy the commodity at the specified price. individual stocks. is a deposit and sometimes it even earns interest. Expiry dates are also specified. there may be several soybean futures selling at the Chicago Mercantile Exchange expiring at different months in the future. Another interesting feature of a futures contract is it always has the exchange (or its “clearing house”) as one party of the contract. Since the future is essentially a promise. However all futures expiring on September 2005. So this should not be considered to be a payment for the future contract. the specifications of a future contract. Trading in agricultural commodities (which category itself spans a wide spectrum from orange juice to cottonseed oil and soybean to livestock) today comprise only about 5% of total futures trade in the world. The future price times the quantity of the commodity specified in the contract is known as the notional value of the contract. On September 23. The actual transaction is scheduled to happen on the expiry date. major stock indices. for instance will expire on the exact same day in September 2005. This margin. the contract is made between the seller and the clearing house.50. except for the price are standardized. 8 . Precious metals.37¾ making the notional value of the contract $ 26. Thus. Firstly. no money changes hands during a futures transaction. At a given time. the closing price of November 2004 soybean future was $5. The specified date in the future contract is the expiration date of the future. there is a margin requirement. oil. 2004. Similarly for the buyer. 887. There are two important features of a future contract. it gives rise to two future contracts. when two people decide of buy and sell a future contract.000 bushels of soybean. currencies. Future contracts are bought and sold regularly on exchanges. Thus a soybean future trading at the Chicago Board of Trade always entails the same quantity (5. and traders in futures have to maintain a small portion of the notional value of the contract with their brokers (members of the exchange where the future trades). For example a soybean contract selling at the Chicago Board of Trade is written for a quantity of 5. however. one between the seller and the clearing house and one between the clearing house and the buyer. Futures are written on a wide variety of commodities and financial assets.000 bushels) of soybeans.Box 1: The basics of a future contract In its essence a future is a contract to deliver a specified quantity of a commodity at a specified date for a certain price. It is the date after which the future contract ceases to exist. As an insurance against non-fulfillment of contract however. The precise day of the month when the future expires is set and known well in by the relevant exchange’s calendar (which typically follows a rule like “Wednesday before the last trading day of the month”). This is done to remove the counter-party risk – the risk that the counter-party to the contract may actually not deliver on the future when the time comes and this enhances the liquidity of futures. For instance when one sells or writes a future.
Online markets have existed for futures on US Presidential elections (the Iowa Electronic Markets) for several elections now and recently “Saddam securities” – futures on Saddam Hussein – were being actively traded on the online exchange. So if a person. Because of the liquidity improvements stemming from standardization. See Leigh et al (2003). Basically anything involving uncertainty that can be objectively resolved in the future is a legitimate underlying asset for futures. forward contracts are hard to unravel.interest rates and weather are all fair game for future contracts and account for most of the trading volume in futures. Thus they are identical in their essence. on the other hand. wants to change his mind and get out of it. The essential feature that distinguishes futures from forwards is the standardization of the former. These features have made futures the instrument of choice for hedgers and speculators worldwide. In case of futures. while forward markets have remained insignificant in comparison. futures contracts are standardized in terms of the quantity of goods to be traded as well as the expiry date. by paying a premium) to the counter-party to agree to nullify the contract. March 2003 and June 2003 contracts were actively trading at one point.e. today it is the futures. December 2002. Forward transactions have been around much longer (dating back to 2000 BC in China) than futures and have been the forerunner of futures. much like the informal and illegal “satta” trading that has flourished in different parts of India for several decades. 9 . a person in a similar situation can simply turn around and sell his contract (or offset it. This standardization works wonders for tradability and liquidity of the future contracts. which dominate trading in this class of instruments. futures are very attractive to speculators who plan to hold them for short periods of time and offset them before their expiry. after entering into a forward contract.) Box 2: Forwards versus Futures Forwards and futures are both contracts to purchase a specified quantity of a good at a specified date in the future. In the case of forward contracts. Yet. Because of its customized nature. in futures parlance) to someone else and is immediately freed from all obligations of the contract. Thus the main difference between forwards and futures is that of standardization and liquidity. they provide an opportunity for betting. As we discussed in Box 1. The presence of such speculators in the market in turn creates even more liquidity of the futures as well over 90% of the total trade in futures is done by speculators. In this sense. both these features vary from contract to contract so each forward contract can be potentially customized to the needs of the buyer and seller. Tradesports.com! (These latter contracts were simple bets that promised the buyer of a contract $10 if Saddam Hussein ceased to be the leader of Iraq by the expiration date of the contract. the only way he can do that is by convincing (i.
Let John be a person purchasing the future and Sheila a person selling it. the Queen of England. there are rules and conventions for deciding that). He had only put up some money with his broker as margin. among others. In order to compensate them for this change John is paid. the future price rises to $ 5.71 per bushel. A natural question that arises is about the reason for having the marking to market practice. for John and Sheila. September 20. they both offset their positions the first thing on Tuesday and for simplicity let their selling price be the same as Monday’s closing price. the size of the contract). right away. Even if the margin money is considered an investment. the rates of return for John and Sheila. Futures are marked-to-market everyday. the percentage gain for John for a single day is (assuming a 5% margin rate) is 14%! Clearly. the difference in the notional amount of his contracts – $200 (i. Thus what the marking-to-market mechanism along with the margin system does is increase the leverage for trading (making them that much riskier). such returns are next to impossible in most other markets. a feature that creates massive leverage in trading in futures. Similarly. What that really means is that a contract for delivering 5000 bushels of soybeans on the settlement date in November 2004 just sold for a price of $ 5.04 times 5. undefined.66 per bushel. Now consider the rates of return. Of course. Here is how it works. $ 0.Box 3: Trading in futures: Marking to market and speculation Trading in futures differs from trading in equity and other securities in an important way. This is because John really never paid anything for the futures (ignoring the broker’s commission).66.e. 27 –year-old Nick was trading futures for Barings Bank at Singapore and bet heavily on the Nikkei index futures. like Sheila’s. This feature makes futures the favored instrument among speculators who can make more with futures (if their bets prove right) than with any other instrument. Let us say. banker to. Let us say that at 10 am Monday. strictly speaking. Sheila has to pay up that same amount of money. Now that means if both people hold on to their contracts till maturity and futures prices did not change at all (a very unlikely situation). the rate of return is -14%. What marking to market means is that the contract that John bought and the one that Sheila sold are now cancelled and replaced with a new contract at the closing price (the closing price is not necessarily the last trade of the day.000 bushels of soybeans. are. The Nikkei fell. for a wrong bet. The 10 . Since rates of returns the calculated on the profit from roundtrip trades divided by the amount of money invested. Now let us at closing on Monday. The reason becomes clear when we consider the real-life story of Nick Leeson and the fall of Barings Bank. 2004 the soybean futures price at Chicago Board of Trade for a contract ending November 2004. is $5. John would have to pay 4 cents more than he bargained for per bushel of soybean (and Sheila would be getting the same amount more). immediately. In 1987. but Nick hid his losses with some crafty (and highly irregular) accounting practices and went on betting on the Nikkei futures. The money is deducted from Sheila’s margin account and debited to John’s.
ING bought up Barings for a princely sum of $1. This is because of the marking-to-market feature.000 bushels of soybean at $ 5.66 per bushel. So she sells a futures contract – 5. To understand this let us go back to the example of John and Sheila once more. What may seem puzzling. is how futures could serve as effective hedging instruments if the prices of the contract do not stay fixed.old institution. Let us assume that Sheila is a soybean grower trying to hedge the price risk of her crop. Now that the price changes on Monday. the total cash flow to her (the sum of her gains or losses on her margin account and the final settlement price times the quantity when she makes delivery on the futures contract) will remain exactly $ 28. 11 . which forced Barings to pay up the losses. after this discussion.Nikkei continued falling and Barings’ losses mounted. The only institution that went relatively unscathed through the whole ordeal was the futures exchange. Barings’ total losses amounted to $ 610 million. Nick Leeson went to prison for his wrongdoings. However. futures fulfill their function as hedging instruments. Thus. which had collected on all but the last day’s losses from Barings Bank. rather than let them accumulate. Thus if she holds on to the contract till maturity. what she gets for that is a revised contract with a higher sale price. regardless of the price variation and marking to market. as they occurred. sinking the over-two-centuries. the amount that she had sold the futures for. she has to pay up $ 200 immediately. with the gain in the futures price exactly offsetting the money she has to pay. The marking-to-market feature just makes them great for speculation too. in spite of the marking-to-market feature.300. When it all came to light.
55 per bushel of his crop whereas the spot price he actually sold at was 15 cents lower. It really makes no difference which choice he makes.50 per bushel while the December soybean futures price is $ 5. By doing this. the magnitude of the basis declines. he would find it difficult to reduce his delivery commitments. Let us say on the day of maturity of the contract.55 per bushel. the two prices must be the same. Let us say the present time is September. So our farmer sells a December futures contract at $ 5.Box 4: Hedging with futures Consider a farmer expecting a soybean harvest in 3 months. or the spot and the futures prices converge. This is intuitive as the basis is driven by interest costs and expected price movements before maturity. the spot price (and hence the futures price of the maturing contract. On the day of the maturity. Now as time passes. Thus he has used the futures market to hedge his risk. the farmer must have earned the 15 cents decline in price per bushel during the 3 months life of the contract. except that sometimes the futures contract delivery may require him to transport his produce to a center further away from his own market of choice. we can be sure of one thing. Let us say the soybean price now is $ 5. The advantage of futures market over forwards is easy to understand if we consider the case of an output risk.40 per bushel. the farmer has to lower the estimate of his crop yield. he has still ensured a cash flow of $5.55 a bushel. On the day of maturity of the contract. This difference of 5 cents between the futures price and the spot price is called basis. Suppose halfway through the crop season. In the case of futures. If he were in a forward contract. So while we do not know how the spot and futures prices would move between now and maturity of the contract. he can “square off” part of his position to have only the necessary delivery commitments that is commensurate with his new yield expectations. he can choose either to fulfill the contract and deliver on it or just to square off the contract and sell his produce in the spot market. as there is no difference between transaction in a futures contract maturing today and that in a spot contract. In that case he can reverse the contract and sell his crop in his local market (assuming that the price in the local market is same as that in the location of the future’s designated center). so the farmer faces risk in the variability of December soy bean price. too) is $5. 12 . Because of marking to market.
Global supply of sugar. has been surplus for several years and sugar prices have remained within bounds. Most certainly the initial rise was partly fuelled by uncertainties created by the prospects of war in Iraq as well as the Brazilian sugar producers’ promise to raise their supply to domestic ethanol producers. 5 white sugar contract account for most of the sugar futures trading in the world. Supplies of commodities like sugar. A lot of trading is done just to arbitrage away price differences between these contracts. May/June 2003 13 . Though financial futures are their instruments of choice. Such speculators often bet on short-term technical analyses of future price trends rather than fundamentals. for instance. FI Magazine. Of course. particularly because of their low correlation with financial and currency futures.000 contracts in February 2003 from which it fell a sharp 22% in a matter of two and half months. saw its open interest in the raw sugar futures contract climb to a record high of over 273. However. speculation is all about taking risks and strategies fail roughly as often as they succeed. The rise of managed funds created for betting in futures markets has added new force to speculation and volatility. react very slowly to price changes. NYBOT’s No.Box 5: Sweet Future? Speculation in sugar contracts The New York Board of Trades. the LIFFE contract is far less attractive to speculators given its limited liquidity and shorter horizon. But other than that. which has a growing cycle of over a year and a half. where 80% of sugar trades take place. Expected glitches in transportation (like the expected fallout of Iraq invasion) may however cause temporary price swings. “Product Profile: Why Bears Like Sugar”. commodity futures are being used too. it was also exacerbated by the involvement of investment funds in speculation whose departure brought the level of trading (and prices) crashing down. 11 world raw sugar contract and LIFFE’s no. Source: Bennett Voyles.
i. where the benefits increase disproportionately with the number of participants. it is probably safe to say that ECNs are still in their nascent stage with relatively fewer participants than in established exchanges. Participants can place orders directly at the ECN’s website. attracting participants located time zones away from one another including.e. After all. prices at which they are willing to buy/sell a specified quantity of securities or commodities. Several such ECNs have come into existence in recent years and are supplementing as well as competing with the established exchanges. Also ECNs can. Island and RediBook are some of the more famous ECNs that are challenging the might of some of the world’s leading stock exchanges like the NYSE and NASDAQ. The main advantages of trading on ECNs include a reduction in the spread charged by brokers and market makers as well as after-hours trading. it is perhaps only a matter of time when a few of the ECNs will emerge as the world’s leading securities exchanges. Archipelago. at least in principle. However. the economics of exchanges is driven by the economics of networks. 14 . international investors. The resulting electronic limit order book – the list of such buy and sell orders – is on continuous public display at the website of the ECN and is updated on a real-time basis. In spite of their obvious advantages. function without any geographical limitations.Box 6: Electronic Communications Networks (ECNs) ECNs are electronic markets where participants submit their limit orders.
SHANGHAI FUTURES EXCHANGE OSAKA SECURITIES EXCHANGE STOCKHOLMSBÖRSEN NATIONAL STOCK EXCHANGE OF INDIA NEW YORK BOARD OF TRADE Others 0 50 100 150 200 Millions of contracts 250 300 350 400 15 .Futures trading volume around the world EUREX CHICAGO MERCANTILE EXCHANGE CHICAGO BOARD OF TRADE EURONEXT MEXICAN DERIVATIVES EXCHANGE NEW YORK MERCANTILE EXCHANGE BM&F THE TOKYO COMMODITY EXCHANGE Exchange KOREA STOCK EXCHANGE LONDON METAL EXCHANGE SYDNEY FUTURES EXCHANGE SINGAPORE EXCHANGE CENTRAL JAPAN COMMODITY EXCH. INTERNATIONAL PETROLEUM EXCH.
.... Kochi (IPSTA) Vijai Beopar Chambers Ltd. Hapur COMMODITY Pepper (both domestic and international contracts) Gur. Oil & Bullion Merchants Association. EXCHANGE India Pepper & Spice Trade Association. Gwalior E-sugar India Ltd.. Kochi Copra/coconut.. Ahmedabad Castor seed. Calcutta Hessian & Sacking The East India Cotton Association Ltd. cotton (kapas) and RBD palmolein. Rajkot The Ahmedabad Commodity Exchange.. Mustard seed its oil & oilcake Gur Gur . Mumbai National Multi-Commodity Exchange of India Ltd. Meerut Gur Oilseed Complex The Bombay Commodity Exchange Ltd. its oil & cake. cottonseed.Table 1: Exchanges and Commodities where futures contracts are traded. Muzaffarnagar Rajdhani Oils & Oilseeds Exchange Ltd. its oil and oilcake The East India Jute & Hessian Exchange Ltd. Soyaoil and Soya meals. Potatoes and Mustard seed The Meerut Agro Commodities Exchange Ltd. National Board of Trade. Mumbai * Castor oil international contracts Rajkot Seeds. Mustard seed Gur. Bhatinda The Chamber of Commerce.. Ahmedabad ** Gur and Mustard seed Sugar Several Commodities (see Table 3) 16 .. Indore** Cotton Turmeric Soya seed.. Sangli. Mumbai The Spices & Oilseeds Exchange Ltd. cottonseed... Rapeseed/Mustardseed its oil and oilcake and RBD Palmolien ( see table 3) The First Commodities Exchange of India Ltd. Castorseed. its oil & cake. Groundnut. Delhi Bhatinda Om & Oil Exchange Ltd. its oil & oilcake Central India Commercial Exchange Ltd.
Source: Ministry of Consumer Affairs. Guar seed.gov. Exchange Ltd. Connoor SGI Commodity Exchange. Mumbai Commodities Sugar Tea Soya bean Ground nut their oils and oilcakes.. Surendranagar Cotton. Cottonseed.Coffee Futures Exchange India Ltd. Mumbai ** Bikaner commodity Exchange Ltd. Bangalore Coffee Surendranagar Cotton Oil & Oilseeds ... Hyderabad United Planters Association of South India... Visit the Forward Trading Commission website (www.in) for later updates. Guar Gum Mustard seed complex Mustard seed Complex Approved Exchanges coming up soon Association M/s. Hissar Bullion Association Ltd.. Mumbai ** Multi Commodity Exchange Ltd. New Delhi National Commodity & Derivatives .fmc. Food and Public Distribution. 17 .. Gram. NCS Infotech Ltd. Kapas E-Commodities Ltd.. Jaipur ** Nation-wide Multi Commodity Exchange Sugar (trading yet to commence) Several Commodities (see Table 3) Several Commodities (see Table 3) Mustard seed its oil & oilcake. Bikaner Haryana Commodities Ltd. GOI website Information is valid as of July 2004.
Safflower Oil. Rapeseed/Mustardseed Oil. Rapeseed/Mustardseed oil-Cake. Crude Palm Oil. Steel – Long. National Agricultural Co-operative Marketing Federation (NAFED). Medium Staple Cotton Screenbased trading 186 18 . Wheat. Sate Bank of India. Tin. Tin. Sugar. Gram. Gujarat State Agricultural Marketing Board (GSAMB). Sacking. Castorseed. Gold. Groundnut Oil. Corporation Bank. Safflower OilCake. Aluminium Ingots. Soybean Oilcake. Kilo – Gold. Sanflower OilCake. Urad. Rapeseed/Mustardseed. Silver. Castorseed. Cardamom. Gujarat Agro Industries Corporation Ltd. Linseed. Soy bean. Soy Oil. Sesamum oil. Cottonseed – Oilcake. Neptune Overseas Limited (NOL). Vanaspati. Tur / Arhar. Gram. Urad. CastorOil Cake. Pepper.Table 2: National-level Futures trading Exchanges in India Exchange Location Year Started 2003 Promoters Commodities Trading Mechanism Screenbased trading Membe rship 89 National MultiCommodity Exchange (NMCE) Ahmedabad MultiCommodity Exchange (MCX) Mumbai 2003 Central Warehousing Corp (CWC). Castor-oil. Pepper Domestic-MG1.. Punjab National Bank (PNB) Financial Technologies (India) Ltd. Groundnut oilcake. Ref Soya oil – Indore. Lead. Steel – Flat. Guarseed. Canara Bank Gur. Linseed. Oilcake. Raw Jute RBD Pamolein. Masoor. Rubber. Copra. Coconut Oilcake. Guarseed. Rubber. Groundnut Oil. RBD Pamolein. Sesamum OilCake. National Institute of Agricultural Marketing (NIAM). Silver-M. Sunflower Seed. Coconut oil. Copper. Nickel. Sunflower Oil. Bank of India. (GAIC). Linseed Oil. Gold. Zinc. Rice Bran Oil. Long Staple Cotton. Nickel. Soy bean. Groundnut. Rice. Safflower. Sesamum (Til or Jiljili). Kapas. Copper. Wheat. Rice. Rapeseed – 42. Cottonseed – Oilcake. Silver. Castorseed-5 . Tur / Arhar. Union Bank of India. CottonSeed. Yellow Peas. Moong. Gold-M. Castor-oil. Crude Palm Oil. Cottonseed oil.
Sugar M Grade. Soy Meal Rapeseed/Mustardseed. Soy bean. Crude Palm Oil Screenbased trading 378 National Board of Trade (NBOT) Indore 1999 Open outcry 71 19 . Soy Oil. NABARD. Yellow Peas. IFFCO. PNB.1 Kg. Canara Bank S06 L S Cotton. Pure Silver . Guarseed. Ref Soya oil. Castorseed. Wheat SMQ. Urad. Jute (B twill-665 Gms). Rape/Mustard seed. EXP R/M oil. Raw Jute. Soy Meal. Pure Gold. Crude Palm oil. Gram(Chana). Rapeseed/Mustardseed Oil. Pure Silver. J34 M S Cotton.30 Kg (Mega). Rubber. RBD P'Olein. LIC. NSE.Table 2 (Contd): National-level Futures trading Exchanges in India National Commodities and Derivatives Exchange (NCDEX) Mumbai 2003 ICICI Bank. GuarGum. Turmeric. Soy bean. Sugar S Grade. Pure Gold . Rapeseed/Mustardseed oil-Cake. Pepper. CRISIL.
m.m. 3 months prior to the contract month i. 5. Feb 2003 contract opens on 21st November 2002. There will be a total of twelve contracts in a year.m. Indore Trading in any contract month will open on the 21st day of the month. * 10 Quintal (=1 MT) 100 Quintal (=10 MT) Rs per Quintal 5 paise Limit 10%. 20 crore. 20th day of the delivery months.00 a.ncdex. Single Call Market (Closing session) for determination of Closing Price: 2.00 p. 10% of open interest) None Trading hours Unit of trading Delivery Unit Quotation/Base Value Tick size Price Band Quality specification Quantity variation No.m.00 p. to 2.30 p.m. to 11.Table 3: Futures Contract Specifications – Soy Bean Contract on NCDEX Trading system NCDEX's Trading System Trade timings on all trading days: Trading Hours : 10.e.30 p. Member-wise: Max (Rs. 15% of open interest) Client-wise: Max (Rs.00 p. Moisture: 10% Max Sand/Silica: 2% Max Damaged: 2% Max Green Seed: 7% Max +/. of active contracts Delivery Centers Opening of Contracts Due Date Position limits Premium/Discount * In addition to the trading hours mentioned above. to 11. 40 crore..m.2% At any date. trading on Saturdays is as follows: Trade timings: 10. Source: NCDEX website (www.00 a. if 20th happens to be holiday then previous working day.com) 20 .m. to 2.m. Single Call Market (Closing session) for determination of Closing Price: 11.00 p. to 4.m.m.15 p. 3 concurrent month contracts will be active.15 p. Limits will not apply if the limit is reached during final 30 minutes of trading.
15th day of the delivery months if 15th happens to be holiday then previous working day. seller can tender Warehouse Receipt for settlement and Warehouse Receipt will be accepted for settlement at closing price of the previous day. No fresh positions building will be allowed. Source: NMCE website (www. 10% above and below the last closing price. of delivery Contracts in a year Delivery Centers Opening of Contracts Due Date Closing of Contract SOYS SOYSF SYSMMMYYYY NMCE’s Derivatives Trading and Settlement System Monday to Friday 10:00 am to 4:00 pm Saturday 10:00 am to 2:00 pm 1 MT 1 MT 20 Kgs 10 paise 5% above and below the last traded price.nmce.com) 21 . From 10th to the 15th of delivery month. Indore Trading in any contract month will open on the 16th day of the month. th th Squaring up of positions will be permitted between 10 and 15 of delivery month. Moisture – 10% Max Sand/Silica – 2% Max Damaged – 2% Max Maximum 12 monthly or minimum 2 monthly contracts running concurrently.Table 4: Futures Contract Specifications – Soybean Contract at NMCE Asset Code Product Code Series Code Trading System Trading Hours Unit of Trading Delivery Unit Quotation/Base Value Tick Size Price Band Quality Specification No. 12 months prior to the contract month.
m. then previous trading day.2:15 pm to 2:30 pm.08% Max Polarisation : 99. 10 Crores. if any Seller with open position desires to give delivery at a particular delivery center. Client–wise: Max (Rs.com) 22 . If the opening day happens to be a non-trading day. whichever is higher. Ex-warehouse basis Muzaffarnagar inclusive of all taxes 10000 Kgs (=10 MT) Rs. November and December 2004 and April 2005 contracts to be launched on July 27. Limits will not apply if the limit is reached during final 30 minutes of trading Member-wise: Max (Rs. contracts would open on the next trading day 20th day of the delivery month. 10% of open interest). 20 Crores.10:00 am to 4:00 pm and 5:00 pm to 11:00 pm.10:00 am to 2:00 pm.150 could be accepted as good delivery but with a premium of Rs. Subsequently trading in any contract month will open on the 21st of the month.Table 5: Futures Contract Specifications – Sugar Contract on NCDEX Trading system NCDEX Trading System Mondays through Fridays: Trading Hours . On the expiry date. 25 per quintal Trading hours Basis Price Unit of trading Quotation/base value Tick Size Ticker Symbol Delivery Unit Quality Specification Quantity Variation Delivery Center Delivery No. If 20th happens to be a Saturday or Sunday then the due date shall be the immediately last preceding trading day of the Exchange All open positions will be settled as per general rules and product specific regulations Limit 10% or as specified by Exchange from time to time. Closing Session . Closing Session .11:15 pm to 11:30 pm Saturdays: Trading Hours . then the corresponding Buyer with open position as matched by the process put in place by the Exchange shall be bound to settle by taking physical delivery Maximum 12 contracts or minimum 2 contracts running concurrently October.00 SUGARMMZR 10 MT net basis packed in 50 kgs new A Twill Bags / PP bags Sugar in crystal form manufactured by vaccum pan method of current season with : Moisture : 0.ncdex. per Quintal Re. whichever is higher M grade sugar with ICUMSA 100 . contracts expiring on that day will not be available for trading after 4 p. If 20th happens to be a holiday. 15% of open interest). 2004.80% Min ICUMSA : > or = 150 ICUMSA and < 200 ICUMSA as determined by GS2/3 METHOD 8 prescribed in Sugar Analysis ICUMSA Method Book Grade : M Grain Size : Medium as determined by the methods prescribed in IS:498-2003 +/. 1. of Active contracts Opening of contracts Due Date Closing of contract Price Band Position Limits Premium * Also deliverable at designated warehouses at Delhi and Kolkata subject to location premium/discount differences which shall be announced by the Exchange from time to time. Source: NCDEX website (www.5% Exchange certified warehouse in Muzaffarnagar * Upon expiry of the contracts.