Commodities Market : Derivatives : AS Chakravarthy NCFM Academy

Commodity Derivatives Market : AS Chakravarthy NCFM Academy

AS Chakravarthy NCFM Course in Hyderabad : Stock Market Training

Why Commodity Derivatives introduced worldwide?

The origin of derivatives can be traced back to the need of farmers to protect themselves against fluctuations in the price of their crop. From the time of sowing to the time of crop harvest, farmers would face price uncertainty. Through the use of simple derivative products, it was possible for the farmer to partially or fully transfer price risks by locking-in asset prices. These were simple contracts developed to meet the needs of farmers and were basically a means of reducing risk side.

A farmer who sowed his crop in June faced uncertainty over the price he would receive for his harvest in September. In years of scarcity, he would probably obtain attractive prices. However, during times of oversupply, he would have to dispose off his harvest at a very low price. Clearly this meant that the farmer and his family were exposed to a high risk of price uncertainty.

On the other hand, a merchant with an ongoing requirement of grains too would face a price risk – that of having to pay exorbitant prices during dearth, although favorable prices could be obtained during periods of oversupply. Under such circumstances, it clearly made sense for the farmer and the merchant to come together and enter into a contract whereby the price of the grain to be delivered in September could be decided earlier. What they would then negotiate happened to be a futures-type contract, which would enable both parties to eliminate the price risk.

Today, derivative contracts exist on a variety of commodities such as corn, pepper, cotton, wheat, silver, etc. Besides commodities, derivatives contracts also exist on a lot of financial underlying like stocks, interest rate, exchange rate, etc.

History of Commodity Derivative Markets

The Commodity derivative was first introduced in Chicago Board of Trade in the year 1848, where as the first futures clearing house came into existence in 1925.

Commodity futures markets have a long history in India. Cotton was the first commodity to attract futures trading in the country leading to the setting up of the Bombay Cotton Trade Association Ltd in 1875.

Futures trading in oil seeds started in 1900 with the establishment of the Gujarati Vyapari Mandali, which carried on futures trade in groundnut, castor seed and cotton.

Calcutta Hessian Exchange Ltd. was established in 1919 for futures trading in raw jute and jute goods. But organized futures trading in raw jute began only in 1927 with the establishment of East Indian Jute Association Ltd.

Futures trading in bullion began in Mumbai in 1920 and subsequently markets came up in other centres like Rajkot, Jaipur, Jamnagar, Kanpur, Delhi and Kolkata.,

1952 Forward Contracts (Regulation) Act, 1952, was enacted.

The Act provided for 3-tier regulatory system:
(a) An association recognized by the Government of India on the recommendation of Forward Markets Commission,
(b) The Forward Markets Commission (it was set up in September 1953) and
(c) The Central Government.

Forward Contracts (Regulation) Rules were notified by the Central Government in July, 1954.

The National Agriculture Policy announced in July 2000 and the announcements of Hon’ble Finance Minister in the Budget Speech for 2002-2003 were indicative of the Governments resolve to put in place a mechanism of futures trade/market.

The year 2003 is a landmark in the history of commodity futures market witnessing the establishment and recognition of three new national exchanges [National Commodity and Derivatives Exchange of India Ltd. (NCDEX), Multi Commodity Exchange of India Ltd (MCX) and National Multi Commodity Exchange of India Ltd. (NMCE)]

The Cash Market settlement process begins as soon as member’s obligations are determined through the clearing process. The clearing banks and depositories provide the necessary interface between the custodians/clearing members (who clear for the trading members or their own transactions) for settlement of funds/securities obligations of trading members. The clearing corporation provides a major link between the clearing banks, clearing members and the depositories. This link ensures actual movement of funds and securities on the prescribed pay-in and payout day. The core processes involved in the settlement process are:

The cash market settlement process for transactions in securities in the CM segment of NSE is presented in the below:

Present Traded Commodities in Indian Commodity Markets:

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