MANGAL KESHAV
Dhanashri Academy
MANGAL KESHAV
Snapshot of Indian Commodity Market
MANGAL KESHAV Two Major Commodities Exchange in India MCX (Multi Commodity Exchange)
NCDEX (National Commodities & Derivatives Exchange)
MANGAL KESHAV Commodities traded on the exchanges
Agri Products: Jeera Pepper Chilli Turmeric Guar Seed Guar Gum Soya bean Sugar Maize
Precious Metals: Gold Silver Platinum
MANGAL KESHAV Commodities traded on the exchanges Base Metals: Copper Nickel Lead Zinc Aluminum Tin
Energy: Crude oil Natural Gas
MANGAL KESHAV 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
MANGAL KESHAV 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
MANGAL KESHAV 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
MANGAL KESHAV 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)
MANGAL KESHAV 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
MANGAL KESHAV 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
MANGAL KESHAV 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
MANGAL KESHAV 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
MANGAL KESHAV Purpose
Hedging
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
MANGAL KESHAV 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
MANGAL KESHAV 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 Expecting/having stock
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/-
MANGAL KESHAV Short Hedge- Example contd‌ Date
Spot
Future
30th Nov
Rs. 280/Kgs
Rs. 295/Kgs
30th Nov
Buy/Hold
Sell
With Hedge (You rule out a loss) 30th Dec
Spot
Future
Net Result
Case 1 -
Loss Rs. 10/Kgs
Profit
Profit Rs. 15/Kgs
Case 2 -
Profit Rs. 25/Kgs
Loss Rs. 10/Kgs
Profit Rs. 15/Kgs
Loss Rs. 10/Kgs
--
Loss Rs. 10/Kgs
Rs. 270/Kgs Rs. 305/Kgs
Rs. 25/Kgs
Without Hedge Case 1 Rs. 270/Kgs
MANGAL KESHAV 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/-
MANGAL KESHAV Long Hedge - Example contd‌ Date
Spot
Future
30th Nov
Rs. 280/Kgs
Rs. 295/Kgs
30th Nov
Wait till Nov
Buy
With Hedge (You rule out a loss) 30th Dec
Spot
Future
Net Result
Case 1 Rs. 270/Kgs
Profit Rs. 10/Kgs
Loss Rs. 25/Kgs
Loss
Case 2 Loss Rs. 305/Kgs Rs. 25/Kgs
Profit Rs. 10/Kgs
Loss
--
Profit Rs. 10/Kgs
Rs.15/Kgs Rs. 15/Kgs
Without Hedge Case 1 Profit Rs. 270/Kgs Rs. 10/Kgs
MANGAL KESHAV
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