Purpose of Commodities Futures

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Presentation Description

Recently, there is a huge increase in the number of traders trading futures contracts. This can be of many reasons

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Presentation Transcript

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Dhanashri Academy

Snapshot of Indian Commodity Market :

Snapshot of Indian Commodity Market

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Two Major Commodities Exchange in India MCX (Multi Commodity Exchange) NCDEX (National Commodities & Derivatives Exchange)

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Commodities traded on the exchanges Agri Products: Jeera Pepper Chilli Turmeric Guar Seed Guar Gum Soya bean Sugar Maize Precious Metals : Gold Silver Platinum

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Commodities traded on the exchanges Base Metals: Copper Nickel Lead Zinc Aluminum Tin Energy: Crude oil Natural Gas

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Other Information Exchange Timings Agri Products: 10:00 AM To 5:00 PM Other Commodities: 10:00 AM To 11:30 PM Instrument Traded: Futures Contract Expiry of Contracts : Different for different commodities

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What are Commodity futures? A Financial Contract The underlying commodity is bought or sold at a future date A tool used by Investors, Hedgers, Arbitrageurs, Day Traders

Why futures trading in Commodities?:

Why futures trading in Commodities? Portfolio diversification and risk management Additional investment opportunity Low cost business No Transportation, storage, insurance, security charges Low Margins – High leverage Intrinsic value of the commodity Domain knowledge of industry Hedging/ Arbitrage

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Purpose of Futures Markets Meet the needs of three groups of future market users Those who wish to discover information about future prices of commodities (suppliers) Those who wish to speculate (speculators) Those who wish to transfer risk to some other party (hedgers) Those who want to take advantage of price difference in different markets (Arbitrageurs)

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Commodity Futures Market – Participants Hedgers Producers – Farmers Consumers – Refineries, Food processing companies Speculators Institutional proprietary traders Brokerage houses Spot Commodity traders Arbitrageurs Brokerage houses Investors

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Exchange vs. Bilateral Trading Exchange Bilateral trading Common platform for all traders Restricted access Price transparency Traded prices unknown to other players Low transaction costs High cost and time consuming negotiations Absence of counter party credit risk Counter party credit risk Market prices available to wider world Difficulty in price dissemination

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Risks encountered by industry Price volatility depends on International market movement Results in higher procurement cost reducing operational margins No options or tools were available earlier Directionless market No control measures Counter party Risk Credit risk especially during periods of volatile prices Quantity risk during shortages Quality Risk

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Benefits… Investor: Portfolio diversification and risk management Additional investment opportunity Physical trader : Low cost business No Transportation, storage, insurance, security Charges Domain knowledge of industry Traders: Low Margins – High leverage No balance-Sheet, P&L, EBITDA Hedging/ Arbitrage

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Hedging Purpose Avoid risk of adverse market movements Rationale Cash and Futures prices tend to move in tandem Converge at close to expiry Types of Hedges Long Hedge, Short Hedge Advantages Lock in a price and margin in advance Disadvantages Limits opportunities if prices move favorably

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Types of Hedging Long Hedge Hedges that involve taking a long position in futures contract Appropriate when a company plans to owns certain asset in the future Short Hedge Hedges that involve taking a short position in futures contract Appropriate when the hedger already owns the asset or likely to own the asset and expects to sell it in future

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Short Hedge - Example Suppose:- COPPER producer wants to sell COPPER in future . There is an equal chances of price going up or down. There is a risk if price goes down. Copper Producer Stock Expecting/having stock 50000 Kg (50MT) of Copper Case If price goes up by Re. 1 Gain – Rs. 50000/- If price goes down by Re. 1 Loss – Rs . 50000/-

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Short Hedge- Example contd… Date Spot Future 30 th Nov Rs. 280/Kgs Rs. 295/Kgs 30 th Nov Buy/Hold Sell With Hedge (You rule out a loss) 30 th Dec Spot Future Net Result Case 1 - Rs. 270/Kgs Loss Rs. 10/Kgs Profit Rs. 25/Kgs Profit Rs. 15/Kgs Case 2 - Rs. 305/Kgs Profit Rs. 25/Kgs Loss Rs. 10/Kgs Profit Rs. 15/Kgs Without Hedge Case 1 - Rs. 270/Kgs Loss Rs. 10/Kgs -- Loss Rs. 10/Kgs Case 2 - Rs. 305/Kgs Profit Rs. 25/Kgs -- Profit Rs . 25/ Kgs

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Long Hedge- Example Scenario of consumer who wishes to lock input prices There is an equal chances of price going up or down. There is a risk if price goes up. Copper Consumer Stock Wants to buy Copper in future 50,000 Kg (50 MT) of copper Case If price goes up by Re. 1 Loss – Rs. 50000/- If price goes down by Re. 1 Gain – Rs . 50000/-

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Long Hedge - Example contd… Date Spot Future 30 th Nov Rs. 280/Kgs Rs. 295/Kgs 30 th Nov Wait till Nov Buy With Hedge (You rule out a loss) 30 th Dec Spot Future Net Result Case 1 - Rs. 270/Kgs Profit Rs. 10/Kgs Loss Rs. 25/Kgs Loss Rs.15/Kgs Case 2 - Rs. 305/Kgs Loss Rs. 25/Kgs Profit Rs. 10/Kgs Loss Rs. 15/Kgs Without Hedge Case 1 - Rs. 270/Kgs Profit Rs. 10/Kgs -- Profit Rs. 10/Kgs Case 2 - Rs. 305/Kgs Loss Rs. 25/Kgs -- Loss Rs . 25/ Kgs

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