In 2003, India lifted its ban on commodity trading after a period of 40 years. Since then this market has caught many an investors eye. The Foreign Currency Regulation Act (FCRA) defines commodities as ‘every kind of movable property other than actionable claims, money, and securities.’ Commodity trading is the trading in commodity spot and derivatives (futures). If you are keen on taking a buy or sell position based on the future performance of agricultural commodities or commodities like gold, silver, metals, or crude, then you could do so by trading in commodity derivatives. Commodity derivatives are traded on the National Commodity and Derivative Exchange (NCDEX) and the Multi-Commodity Exchange (MCX). Trading in commodity futures is quite similar to equity futures trading. Like in equity markets, if you think prices are on their way up, you take a long position and when prices are headed south you opt for a short position. The Sebi equivalent in the case of the commodity trading market is the Forward Markets Commission.

What are commodity futures?

A commodity futures contract is a contractual agreement between two parties to buy or sell a specified quantity and quality of commodity at a certain time in the future at a certain price agreed upon at the time of entering into the contract on the commodity futures exchange.

Objectives and benefits of commodity futures

* Hedging – price risk management by risk mitigation

* Speculation – take advantage of favourable price movements

* Leverage – pay low margin to enjoy large exposure

* Liquidity – ease of entry and exit of market

* Price stabilisation along with balancing demand and supply position

* Facilitates integrated price structure

* Flexibility and certainty in purchasing commodities facilitate bank financing

Facilitates ‘informed’ lending by the banks

However the primary objectives for any futures exchange are effective price discovery and efficient price risk management. An investment commodity is generally held for investment purposes whereas consumption commodities are held mainly for consumption purposes. Gold and Silver can be classified as investment commodities whereas oil and steel can be classified as consumption commodities.

Cash and futures market

There are basically two markets present within the commodity markets, the cash market and the future market. The cash market is the market for buying and selling physical commodity at a negotiated price. Delivery of the commodity takes place immediately. While the futures market is the market for buying and selling standardised contracts of the commodity at a pre-determined price. Delivery of the commodity takes place during a future delivery period of the contract if the option of delivery is exercised.

Who’s who?

Another area that those entering the commodities markets should be aware of are the kinds of people you dealing with. Unlike the share market, there are no animals here (bears and bulls), however, the participants in commodity derivatives are of different mould all together. Broadly speaking they can be classified into

* Hedgers: Hedgers are interested in transferring risk associated with transacting or carrying underlying physical asset.

* Speculators: Speculators are interested in making money by taking a view on future price movements. Commodity futures allow speculators to create high leveraged positions to undertake calculative risks, with the objective of correctly predicting the market movement.

* Arbitragers: Arbitragers are interested in locking in a minimum risk profit by simultaneously entering into transactions in two or more markets. Arbitragers lock in profit when they spot or reverse cash and carry arbitrage opportunity.