Commodity Futures

1. Meaning.2. Objectives of Commodity Markets.3. Participants of Commodity Markets.4. Trading terms and Concepts.

Commodity Futures - Meaning

Explain the origin of derivatives….

A derivative is a financial instrument whose value depends upon the values of the underlying variables like prices of currency, stock, commodity, indices, interest rates. Etc.

Commodity future contract is a contract / agreement entered into between two parties on recognized commodity exchange today, to buy or sell a specified quantity and quality of a commodity at a pre-decided future date at an agreed price today.

DIFFERENCE BETWEEN FORWARD AND FUTURES

FORWARD1. Between Seller and Buyer of

Underlying.2. Traded on Phone or Telex.3. Self regulating.4. Non-standardization. Tailor made

sizes. Thus provide exact hedge.5. Delivery on any date as decided

by parties.6. Suitable to genuine users of forex.

Less speculative.7. Not listed on exchanges, thus

illiquid.8. Settled on due date by actual

delivery of currency.

FUTURES1. Anyone can buy Futures.

2. Traded on Derivatives Exchanges.3. Regulated by Derivatives Exchanges.4. Standardized sizes. Thus, over /

under hedge.5. Delivery on specific dates fixed by

derivative exchange.6. Genuine users as well as speculators

may trade in futures.7. Liquid since listed on exchanges and

thus tradable.

8. Settlement on daily basis either by delivery or Cash settlement for difference in value.

DIFFERENCE BETWEEN FORWARD AND FUTURES

FORWARD9. High Settlement Risk.

10.No market to market.

FUTURES9. Clearing house is counterparty

which reduces the risk.10.Market to Market

Trading Concepts1. Actuals - The physical or cash commodity2. Against actuals / EFP / ex-pit – Also referred to as Exchange for Physical.

A transaction generally used by Hedgers who want to exchange futures for cash positions.

3. Aggregation – The policy under which all futures positions owned or a controlled by one trader or group of traders are combined to determine reporting status or speculative limit compliance.

4. Backwardation - When the prices of spot, or contracts maturing earlier are higher than a particular futures contract, it is said to be trading at Backwardation.

5. Basis – It is the difference between the current cash price of a commodity and the futures price of the same commodity.

6. Basis Grade – The grade of a commodity used as a standard or par grade of a future contract.

7. Basis Risk – The risk associated with an unexpected widening or narrowing of basis between the time a hedge position is established and the time that it is lifted.

Trading Concepts-contd..8. Bear Spread – In most commodities, it refers to selling the nearby

contract and buying the distant contract to profit from saving in the cost of carry.

9. Bucketing -

10.Cash Settlement – It is a process for performing a futures contract by payment of money difference rather than by delivering the physical commodity or instrument representing such physical commodity (like warehouse receipt).

11.Change – It refers to the change in settlement prices from the previous day’s close to current day’s close.

12.Clearing – The procedure through which the clearing house or association becomes the buyer or seller and ensure that the commodity trading is done in time without any hitches with performance of each contract.

Trading Concepts-contd..13.Clearing Member – A member of an exchange clearing house. All

trades of a non-clearing member must be registered and settled through a clearing member.

14.Client Account – It is an account being maintained for any individual or entity being serviced by an agent for a commission.

15.Client Agreement – It is a legal document entered between the broker and the client.

16.Closing price – The price recorded during trading that takes place in the final moments’ of a day’s activity.

17.Contango – It is a situation where futures contract prices are higher than the spot price and the futures contracts maturing earlier.

18.Contract grades – Those grades of a commodity, which have been officially approved by an exchange as deliverable in settlement of a futures contract.

19.Contract Unit – The actual amount of a commodity represented in a contract.

Trading Concepts-contd..20.Convergence – This refers to the tendency of difference between

spot and futures contract to decline continuously, so as to become zero on the date of maturity.

21.Cost of carry – It is the cost of storing a physical commodity over a period of time.

22. Crush Spread – It is a spread in the futures market wherein a simultaneous purchase of main product and the sale of by-product futures is done to establish a processing margin.

23.Daily price Limit – The maximum price advance or decline from the previous day’s settlement price permitted during one trading session, as fixed by the rules of an exchange. ADVANTAGE ????

24.Daily trading limit – The maximum price range set by the exchange each day for a contract.

25.Day trader – A speculator who normally initiate and offset a position within a single trading session.

Trading Concepts-contd..25.Delivery date – The date on which the commodity or instrument of

delivery must be made to fulfill the terms of a contract.26.Hedging – It is a mechanism by which the participants in the

physical / cash markets can cover their price risk.27.Initial Margin – It is the amount to be deposited by the market

participants in his margin account with clearing house before they can place order to buy or sell futures contracts.

28.Liquidation – To sell or purchase futures contracts of the same delivery month purchased or sold during an earlier transaction.

29.Long hedge – 30.Long the basis – A person or firm is said to be long the basis if

they have bought the spot commodity and hedged with a sale of futures.

31.Lowest price – Low refers to the lowest price at which trading took place during the day for a particular contract.

Trading Concepts-contd..32.Margin Call – A call from a clearing house to a clearing member or from a

broker firm to a customer, to bring margin deposits up to a required minimum level.

33.Market correction – In technical analysis, a small reversal in prices following a period of significant up-trend or downtrend in prices.

34. Mark to Market Margin (MTM or M2M) – Mark-to-market, also called as M2M is the margin that is calculated on each trading day by taking the difference between the closing price of a contract on that particular day and the price at which the trade was initiated. In other words, its the practice of crediting or debiting a trader's account based on the daily closing prices of the futures contracts he is holding. Mark-to-market margin is calculated on daily basis to find out the profit or loss on the open futures position. If there is a profit, the amount is transferred from the clearing house to your trading account by the broker, and in case of loss, the amount is transferred by the broker from your trading account to the clearing house. For example, if one buys futures of Rs 5000 and its price fall to Rs 4500. Then s/he has to pay M2M margin of Rs 500 to take the position in the future.

Trading Concepts-contd..35. Net position – The difference between the open long contracts and the

open short contracts held by a trader in any one commodity.36.Offset – It refers to the liquidation of a futures contract by entering into

opposite of an identical contract. 37.Overnight trade – A trade which is not liquidated on the same trading

day in in which it was established.38.Range – The difference between high and low price of a commodity

during a given trading session, week, month, year etc.39.Reverse crush spread – It is a situation in a market wherein a

simultaneous sale of main product and the purchase of by-product futures is done to establish a processing margin.

40. Settlement price – It is the price at which the outstanding trades are settled, i.e. profits and losses, if any are paid off.

41.Warehouse receipt – It is a document issued by a warehouse indicating ownership of the stores commodity and specifying details in respect of some particulars, like, quality, quantity and sometimes the crop season.