Derivatives, such as futures or options, are financial contracts which derive their value from a spot price, which is called the “underlying”. The term “contracts” is often applied to denote the specific traded instrument, whether it is a derivative contract in commodities, gold or equity shares. The world over, derivatives are a key part of the financial system. The most important contract types are futures and options, and the most important underlying markets are equity, treasury bills, commodities, foreign exchange, real estate etc.

Futures markets are exactly like forward markets in terms of basic economics. However, contracts are standardized and trading is centralized (on a stock exchange). There is no counterparty In futures markets, unlike in forward markets, increasing the time to expiration does not increase the counter party risk. Futures markets are highly liquid as compared to the forward markets.

A forward contract is a legally enforceable agreement for delivery of goods or the underlying asset on a specific date in future at a price agreed on the date of contract. Under Forward Contracts (Regulation) Act, 1952, all the contracts for delivery of goods, which are settled by payment of money difference or where delivery and payment is made after period of 11 days, are forward contracts.

A commodity futures contract or commodity derivatives is a commitment to make or accept delivery of a specified quantity and quality of a commodity during a specific month in the future date at a price agreed upon when the commitment is made.
Commodities traded in the commodity exchanges are required to be delivered at the contracted price, ignoring all the changes in the market prices. Both the participants (Buyers & Sellers) are allowed to liquidate their respective positions by way of cash settlement of price between the contracted and liquidated price, no later than the last trading session of the specified expiry date.

An effective and efficient market for trading in commodities futures requires:

Some of the reasons that make investing in commodity futures of MCX Commodity trading an attractive preposition are defined below:

Leverage: Commodity Futures trading is done on margins. The investor only deposits a fraction of the value of the futures contract with the broker to cover the exchange specified margin requirements. This gives the investor greater leverage and thus the ability to generate higher returns.

Liquidity: Unlike investment vehicles like real estate, investments in commodity futures offer high liquidity. It is equally easy to both buy and sell futures and an investor can easily liquidate his position whenever required. There is also another advantage of being able to use the profits from a trade elsewhere, without having to close the position.

Diversification: Investments in commodities market are an excellent means of portfolio diversification. For example, gold prices have historically shown a low correlation with most other asset prices (such as equities) and thus offer an excellent means for portfolio diversification.

Inflation Hedge: As the commodity prices determine price levels and consequently inflation, investing in commodity futures can act as a hedge against inflation.
Large numbers of commodity are traded on commodity exchanges in around the world. The commodities are classified on the basis of their use and consumption. Further classification is based on the characteristics of the commodity. Some of the commodities traded on various futures exchanges are as follows:

Precious Metal: Gold, Platinum, Palladium, Silver etc.

Industrial Metal: Copper, Lead, Zinc, Tin, Aluminum, Nickel, etc.

Energy: Natural Gas, Crude Oil

Food Stuff: Barley, Coffee, Wheat, Sunflower Oil, Cocoa, Sugar, Maize, Rough Rice, Soybean etc.

This predominantly depends on the exchange you are trading in.
In India, commodity trading is predominantly done on two exchanges: Multi Commodity Exchange (MCX) and National Commodity & Derivatives Exchange (NCDEX). The following commodities are actively traded in these two Exchanges:

Multi Commodity Exchange (MCX):

National Commodity and Derivatives Exchange (NCDEX)

For a list of updated listed commodities, please visit www.mcxindia.com and www.ncdex.com.

In the derivatives market, you pay only a small portion of the actual value of the trade. You do not have to pay the entire sum upfront like in the spot market or while buying stocks. This is called Margin.

Simply put, the Margin is the amount you are required to deposit with your broker before you can execute a commodities trade on any exchange.

The amount of money that buyers and sellers of futures contracts are required to deposit upfront with their brokers is known as Initial Margin. This amount ensures that your account has enough money at all points in time. This is mainly for daily settlement of your contract, even if you make a loss on it.

Maintenance Margin is the amount you need to deposit over and above the Initial Margin. This is to ensure that the balance in your account never goes below a pre-specified level. Think about it as the threshold below which your Margin cannot fall. If it does, then you will be asked for Additional Margin.

Additional Margin is the amount your broker will ask you to bring in if the balance in your account falls below the maintenance margin. The objective of bringing in this amount is to protect your open positions from unexpected market volatility.

Every day, the value of your contracts and trades are adjusted to reflect the current market price. This is called Marking to Market (MTM).

So, on the day you enter a futures contract, Mark to Market or MTM is the difference between your entry value and the day’s closing price. In the case of a carried forward position, it is the difference between the day’s market price and the previous day's closing price.

Both exchanges have done exceedingly well over the years, in terms of risk management, volumes and launch of new & better commodity trading products. But before choosing an exchange, you may still check the following:

A hedge is an investment that mitigates the risk of adverse price movements of an asset. The prices of commodities keep fluctuating. To hedge against such price risks, players buy or sell positions in the commodity futures markets. It is mainly the producers/sellers of commodities (e.g., farmers producing wheat) and the consumers/buyers of commodities (e.g., bread manufacturers who use wheat as raw material) who undertake commodity hedging.

It can so happen that momentarily, the commodity may be trading at different prices on the spot and futures markets. In this case, you can purchase at a lower price in one market and sell it at a higher price in the other market. This is called Arbitrage—taking advantage of the difference in prices in two different markets. This is why arbitrage transactions are usually risk-free. Arbitrage helps ensure prices do not vary from each other in two markets. The higher price keeps falling while the lower price rises over time. Eventually, when prices become similar in both markets, arbitrage stops.

Warehouse receipts are title documents issued by warehouses to depositors against the deposited commodities. These documents are transferred by endorsement and delivery. Only the holder of these receipts can claim the commodities from the warehouse.

Every stock has a unique number or code by which the system identifies it. It is called ISIN. Similarly, commodities too have a unique identification number. This is called ICIN number. Every commodity has a different ICIN at different exchanges.

When you trade in the Commodity Futures market, you have a standardized contract. Meaning, every trade has some common traits. The Lot size refers to this common quantity prescribed. You can only trade in multiples of this quantity or lot. However, the quantity for delivery may differ from the minimum lot size. This is called Delivery size.

It costs money to hold commodity products. This is called Cost of Carry. It includes expenditures like storage costs, insurance, interest payments, etc. This is usually taken into account in the commodity futures price like this: Commodity Futures price = Future Spot price + Cost of Carry.

Just before the contract is due for expiry, you have to make up your mind regarding the settlement and delivery of the commodity. This is called Tender period.

This is the difference between the Futures prices of a particular commodity over different tenures. For example, the Futures price of a commodity may be Rs.100 for the 1-month contract and Rs.110 for the 2-month contract. This difference is called the Spread.

This is when you practically try to push your delivery. You do so by closing your current Contract and entering a similar contract due for another month.

This is when enter into two contracts: One to buy a certain commodity over one expiry period; the second to sell the same commodity over another period.

To get out of a contract, you need not take the delivery of the commodity. You can simply pay the difference between the Buy and Sell contracts in cash. This is called Cash settlement.

You have to pay the following charges:

Yes, there are circuit limits (upper and lower) or daily price ranges (DPR) to protect investors from extreme price movements. When a circuit limit is hit, trading is stopped for fifteen minutes. After this trading begins with fresh circuit limits. For updated commodity specific circuit limits, please visit www.ncdex.com and www.mcxindia.com.

Yes, there are maximum permissible holding limits for clients and members. These limits vary by commodity and exchange. Please see contract specifications on www.ncdex.com and www.mcxindia.com for position limits at client and member level.

Yes, there are circuit limits (upper and lower) or daily price ranges (DPR) to protect investors from extreme price movements. When a circuit limit is hit, trading is stopped for fifteen minutes. After this trading begins with fresh circuit limits. For updated commodity specific circuit limits, please visit www.ncdex.com and www.mcxindia.com.