Understanding commodity derivatives trading

National multicommodity exchanges came up in late 2002-2003 after the then NDA government lifted a 40-year ban on forwards trading. These exchanges were regulated by the Forward Markets Commission (FMC) which was merged with Sebi in 2015. Here is a primer.

1. What is a commodity futures contract?

It is a contract to buy or sell a commodity at a preset price for delivery on a future date. Unlike equity futures, however, almost all commodity contracts, barring a few like crude oil and natural gas, result in compulsory delivery.


2. What are the types of commodity futures one can trade in?

Futures have been launched in bullion, base metals and energy, diamond, agri futures like edible oilseed and oils, guar, spices and plantation products such as jute and rubber. The exchanges which offer a commodity segment include MCX, NCDEX, ICEX, NSE and BSE. Options on commodities like gold were introduced in 2017.

3. What are the important parameters of futures trading?

The activeness of a contract can be gauged from the open interest (OI), which when read with price offers valuable clues to a market participant. For e.g, a rise in price accompanied with an increase in OI is a bullish sign (long build-up). A fall in price and a rise in OI is a bearish indicator (short build-up). A rise in price along with a fall in OI signals short covering. And, a fall in OI and decline in price denotes long liquidation, or bulls cutting their positions.

4. What is the risk-return of futures trading?

The profits and losses in futures trading can be huge as it involves taking leverage by putting up a margin to trade. This margin is a fraction of the contract cost.

5. Illustrate

Take a gold futures (1 kilo) contract expiring on December 5.

Based on the base value of 10 gms of Rs 37,900, the contract value is Rs 37.9 lakh. Assuming a buyer pays a margin to trade of 5 per cent, the leverage offered is 20X (Rs 1,89,500). Now, if the price rises the next day by Rs 200 per 10 gm, the gain to the trader at contract value is Rs 20,000. But if the price falls by the same amount the loss is 10.5 per cent since futures trading is a zero sum gain, meaning one man’s loss is the other man’s gain.