A study on commodity markets in India with reference to agricultural products

A study on commodity markets in India with reference to agricultural products

EXECUTIVE SUMMARY

A dissertation study titled A STUDY ON COMMODITY MARKETS IN INDIA WITH REFERENCE TO AGRICULTURAL PRODUCTS has been submitted to Bangalore University as a part of curriculum for the partial completion of Master of Business Administration.

The main objectives of the dissertation study includes,

To study the present scenario of the commodity markets.

To understand the method of pricing agricultural commodity futures.

To understand hedging, speculation and arbitrage in commodity futures.

To analyze agricultural commodities by using technical analysis.

All information relevant to the project has been drawn from both primary and secondary sources:

Primary sources: This includes personal interviews conducted with the professionals in the field.

Secondary sources: Constitutes various books, journals, publications, web sites etc.

The commodity markets are emerging markets in India compared to equity and debt markets. The commodity markets in India are said to be still in nascent phase. But the volume of trading and the number of participants are increasing year over year. India is among the top 5 producers of most of the commodities, in addition to being a major consumer of bullion and energy products. Agriculture contributes about 22% to the GDP of the Indian economy. It employs around 57% of the labor force on a total of 163 million hectares of land. Agriculture sector is an important factor in achieving a GDP growth of 8%. All this indicates that India can be promoted as a major center for trading of commodity derivatives. Therefore there is a need to study the commodity markets. The instruments available for trading in the commodity markets are the forwards, the futures and the options. The forward contracts are mainly traded over the counter. The forwards contracts are tailor made contracts, they can be negotiated where as the futures are standardized contracts. They are traded only on the standardized exchanges. The case of options contracts on commodities is different, they were banned in the year 1952. Therefore the options are not studied in detail. The study mainly focuses on the commodity futures. The study analyses four agricultural products like Chana, Maize, Soybean and Turmeric. The study mainly focuses on the present scenario of these commodities and the market influencing factors. The study provides an outline in which the commodity futures are pricedby using the cost of carry model and the arbitrage arguments.

The research gives a brief description about the national commodity exchanges in India, their management, capital structure and the trading system adopted by them. Though the trading system of all the exchanges is more or less the same, they have some differences in the procedure of trading and settlement. The study gives an outline of the evolution of the commodity markets in India under three periods. Namely, the pre-independence period, the post-independence period and the post-liberalization period. The study focuses on the structure of the commodity markets and their regulations within Indian framework. The Indian commodity markets have three tier regulations. First the central Government, second the FMC and the Exchanges at third tier. The study looks into the trends in the commodity markets.

There are various tools available to track the movements of commodity markets. The study focuses on the technical analysis. The technical tools like Line chart, Simple moving average, the ROC, RSI and Support and Resistance lines are used to analyze the agricultural commodities.

Chapter I

Introduction Commodity

In general, a commodity can be defined as any product that can be used for commerce or an article of commerce, which is traded on an authorized commodity exchange. In business terms, a commodity can be defined as an undifferentiated product, whose market value arises from the owners right to sell rather than use.

The Indian Forward Contracts (Regulation) Act (FCRA), 1952 defines goods as every kind of movable property other than actionable claims, money and securities. In current situation all goods and products of agricultural (including plantation), mineral and fossil origin are allowed for commodity trading recognized under FCRA. The national commodity exchanges, recognized by the central government, permits commodities which includes precious (gold and silver) and non ferrous metals, cereals and pulses, ginned and unginned cotton, oil seeds, oils and oil cakes, raw jute and jute goods, sugar and gur, potatoes and onions, coffee and tea, rubber and spices etc.

Commodity derivatives market

Commodity derivatives market trade contracts for which the underlying asset is commodity. It can be an agricultural commodity like wheat, soybean, rapeseed, cotton, etc or precious metals like gold, silver, etc

Commodity Exchange

A commodity Exchange is an association, or a company of any other body corporate organizing futures trading in commodities. In a wider sense, it is taken to include any organized market place where trade is routed through one mechanism, allowing effective competition among buyers and among sellers this would include auction-type exchanges, but not wholesale markets, where trade is localized, but effectively takes place through many non-related individual transactions between different permutations of buyers and sellers.Forward contracts

A forward contract can be studied in contrast with a spot contract. A spot contract, is an agreement to buy or sell an asset today where as a Forward Contract is particularly a simple derivative, which is an agreement to buy or sell an asset at a certain future time for a certain price. A forward contract is traded in the over-the-counter marketusually between two financial institutions or between a financial institution and one of its clients. One of the parties to a forward contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Forward contracts on foreign exchange are very popular. Most large banks have a "forward desk" within their foreign exchange trading room that is devoted to the trading of forwards.

The features of a forward contract

The forward contracts are tailor made. It means the terms and conditions are negotiated between buyers and sellers.

There are no secondary markets for forward contracts.

Forward contracts generally end with deliveries.

Usually no collateral is required for a forward contract.

Forward contracts are settled on the maturity date, no market to market settlement.

In a forward contract, both the parties have credit risk.

Payoffs

The payoff is the gain or loss arising out of a forward contract during the maturity of the contract. It is important to distinguish between the contract price and spot price to understand the payoffs. The contract price is the market price that would be agreed to today for delivery of the asset at a specified maturity date. The spot price is todays market price.

When Spot price exceeds Contract price: -

Buyers Gain = Spot price Contract price

Sellers Loss = Contract price Spot price

When Contract price exceeds Spot price:-

Buyers Loss = Contract price Spot price

Sellers gain = Spot price Contract priceCommodity Futures Futures markets have been described as continuous auction markets and as clearing houses for the latest information about supply and demand. They are the meeting places of buyers and sellers of an ever-expanding list of commodities that today includes agricultural products, metals, petroleum, financial instruments, foreign currencies and stock indexes. Trading has also been initiated in options on futures contracts, enabling option buyers to participate in futures markets with known risks. A futures contract is a standardized forward contract. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future for a certain price. Unlike forward contracts, futures contracts are normally traded on an exchange. To make trading possible, the exchange specifies certain standardized features of the contract. As the two parties to the contract do not necessarily know each other, the exchange also provides a mechanism that gives the two parties a guarantee that the contract will be honored. The futures contracts are guaranteed for performance. That is the party involved in such a contract need not worry about credit worthiness of other party. The future contracts are standardized contracts developed by Future Exchanges. The exchanges should specify the details about the nature of agreement between the buyer and seller. The exchange should specify the underlying asset, contract size, time and place of delivery, quotation of prices.

Features of a futures contract The future contracts are traded only on standardized stock exchanges. The contracts are standardized. The terms and conditions are framed by the exchanges.

The futures are usually settled in cash.

The settlement takes place on Market to market basis.

The contracts mature on last Thursday of every month.

Margins

The futures market procedure is the system of collateral margins that has evolved as a means to reduce risk of default. As opposed to margins or stock accounts, a futures margin payment is not a form of down payment on the balance due since a futures transaction is not an investment of initial capital in return for a later payoff, but rather, in its purest form, is an agreement made at no initial investment. The parties in a futures contract has to maintain two types of margins namely, Initial margin and Maintenance margin. Initial margin is the margin where the buyers and the sellers in a futures contract at the time of entering into the contract are required to deposit on the futures contract value. The initial margin will be usually 5 to 10 percentage of the futures contract value. The Exchange and Clearinghouse determines the exact amount of margin.

After the initial margin is deposited, a change in the price of future contract would change the percentage relationship between margin and contract value. At the end of each trading day, the margin account is adjusted to reflect the investors gain or loss by Marking to Market basis. Sometimes in the margin account of the investors, it is possible that the margin may be very low or it can be wiped out of balance. To prevent this kind of situation the investor is required to ensure the margin which is called Maintenance margin. It is typically 3/4th of initial margin. Once the margin account falls below 3/4th of initial margin, the investor gets a margin call from broker. The investor should top up his margin account. If the call is ignored, the future contract ceases to exist.

Market to Market basis

The futures contracts are marked to market on a periodic basis. This means that the future contract prices shall be adjusted to the market price of the underlying asset. If the spot market price increases, the buyers margin account shall be credited and the sellers margin account shall be debited. If the spot market price decreases, the buyers account shall be debited and the sellers account shall be credited.

The spot market price of the underlying asset at the end of the trading day shall be taken as the new future contract price. It is known as marking to market price. That is, any change in the spot market price henceforth will affect the margin of investors. Consider table 1.1 to understand the working of margins and market to market.

Table 1.1

To illustrate the operation of market to market and margins, let us consider the following example of a wheat futures contract

DayFuture price (Rs/qntl)Gain/loss (Rs/lot)Margin account balance (Rs/lot)Margin call

(Rs/lot)

LongShortLongShortLongShort

March 1

March 2

March 3

March 4

March 5

March 61100.00

1100.10

1100.30

1099.80

1099.60

1099.70-

1000.00

2000.00

(5000.00)

(2000.00)

1000.00-

(1000.00)

(2000.00)

5000.00

2000.00

(1000.00)11000.00

12000.00

14000.00

9000.00

7000.00

9250.0011000.00

10000.00

8000.00

13000.00

15000.00

14000.00-

-

-

-

1250.00

--

-

250.00

-

-

-

On March 1st, a wheat future contract has been framed. The contract size is 10MT and the price of wheat was Rs.1100 per quintal.

The initial margin is assumed to be 10% of futures contract value and the maintenance margin is assumed to be 3/4th of initial margin.

While entering into the contract, both the positions, the long and the short has to deposit an initial margin of Rs.11000 which is 10 percentage of future value.

On march 3rd when the future value raised from Rs.1100.10 to Rs.1100.30, the long gains Rs.2000 and the short loses Rs.2000 due to which the shorts margin account balance falls below the maintenance margin and the margin call for Rs.250 is made.

Similarly on May 5th, the spot price of the wheat declines from Rs.1099.80 to Rs.1099.60. Now the long loses Rs.2000 due to which his margin account fell down below maintenance margin and receives a margin call for Rs.1250.

Pricing of commodity futures. In the futures markets the free flow of information is vital. Futures exchanges act as a focal point for the collection and dissemination of statistics on supplies, transportation, storage, purchases, exports, imports, currency values, interest rates and other pertinent information. Any significant change in this data is immediately reflected in the trading pits as traders digest the new information and adjust their bids and offers accordingly. As a result of this free flow of information, the market determines the best estimate of today and tomorrows prices and it is considered to be the accurate reflection of the supply and demand for the underlying commodity. Price discovery facilitates this free flow of information, which is vital to the effective functioning of futures market.

The fair value of a future contract can be arrived by using the arbitrage argument. The buyer who needs an asset in the future has the choice between buying the underlying asset today in the spot market and holding it, or buying it in the forward market. If he buys it in the spot market today, it involves opportunity costs. He incurs the cash outlay for buying the asset and he also incurs costs for storing it. If instead he buys the asset in the forward market, he does not incur an initial outlay. However the costs of holding the asset are now incurred by the seller of the forward contract who charges the buyer a price that is higher than the price of the asset in the spot market.

This arbitrage argument forms the basis for the costofcarry model where the price of the futures contract is defined as:

F = S + C

Where: -

F = Futures Price

S = Spot Price

C = Holding cost / Carrying Costs.

Pricing futures contracts on investment commodities

Where: -

r is Cost of financing (Annualized)

T is Time till expiration

U is Present value of all storage costs.Pricing futures contracts on consumption commodities.

Where: -

r is Cost of financing (Annualized)

T is Time till expiration

U is Present value of all storage costs.

Futures Payoffs

Futures contracts have linear payoffs. It means that the losses as well as profits for the buyer and the seller of a futures contract are Unlimited.Payoff for the buyer of futures.

The payoff for a person who buys a futures contract is similar to the payoff for a person who holds an asset. He has a potentially unlimited upside as well as a potentially unlimited downside.

Profit

0

Loss

For illustration, consider an example, a person has bought a three-months future contract on gold for Rs.16300. If the price of the gold in the spot market goes up from Rs.16300 to Rs.16310, the buyer gains Rs. 10 for 10 gms. The gain continues until the spot market price increases. If the price of the gold decreases from Rs.16300 to Rs. 16290, the buyer loses Rs. 10 for 10gms. The loss continues until the spot market price decreases. Therefore the gain or loss is unlimited.

Payoff for the seller of futures contract.

The payoff for a person who sells a futures contract is similar to the payoff for a person who shorts an asset. He has a potentially unlimited upside as well as a potentially unlimited downside.

Profit

0

Loss

To illustrate consider the same example given above. A person has sold a three month futures contract on gold for Rs. 16300. If the price of the gold falls down from Rs. 16300 to Rs. 16290, the seller gains Rs. 10 for 10gms. The gain continues until the spot market price falls. In contrast, if the spot market price increases from Rs. 16300 to Rs. 16310, the seller loses Rs. 10 for 10gms. The loss continues until the spot market price increases.

Therefore it is said that the profits and gains in a futures contract are unlimited. The buyer continues to gain to the extent to which the spot market price increases or continues to lose to the extent to which the spot market price decreases.

Commodity options

A commodity option is the right (not an obligation) to buy or sell a fixed quantity of a commodity at a particular date, or within a specified period, and at a fixed price, called exercise price or strike price. The options can be traded both on OTC and exchanges. The holder will only exercise his option, if the price of the underlying commodity moves favorably, by an amount sufficient to provide a profit when the option is sold. If the price moves in the opposite direction, only the price for the option (called premium) is lost. The option price is therefore a kind of insurance premium. The seller of the option is correspondingly more exposed to risk. Options, as well as futures, enable users and producers to hedge against the risk of wide price fluctuations. However, they also allow speculators to gamble for large profits with limited liability. Therefore the range of users is diverse: a speculator may buy coffee call options in the expectation that unseasonable weather in Brazil will drive up world coffee price, or, an airline may hedge its fuel requirements with kerosene calls.

Kinds of options:

European-style options can only be exercised on the expiry date, whereas American-style options can be exercised at any time between the date of purchase and the expiration date. European-style options are therefore cheaper, but most exchange-traded options are of American-style.

Types of options

The call option is a type of option contract where the option holder has the right to buy the underlying asset for an exercise price on or before the date of maturity. The put option is a type of option contract where the option holder has the right to sell the underlying asset for an exercise price on or before the date of maturity.

However the commodity options are not traded in India, they were banned in the year 1952.

Introduction to hedging, arbitrage and speculation in commodity futures.

Hedging

Many of the participants in futures markets are hedgers. Their aim is to use futures markets to reduce a particular risk that they face. This risk might relate to the price of oil, a foreign exchange rate, the level of the stock market, or some other variable. Hedgers could be government institutions, private corporations like financial institutions, trading companies and even other participants in the value chain. For instance farmers, extractors, ginners, processors etc., those are influenced by the commodity prices.

Types of hedging The short hedge is a hedge that involves a short position in futures contracts. A short hedge is appropriate when the hedger already owns an asset and expects to sell it at some time in the future. The long hedge involves taking a long position in a futures contract. A long hedge is appropriate when a company knows it will have to purchase a certain asset in the future and wants to lock in a price now.

Arbitrage

Arbitrage denotes the purchase and simultaneous sale of the same commodity in different commodity markets in order to take advantage of differences in commodity prices between the two markets. Such a transfer of funds is risk-free, because an arbitrageur will only switch from one market to another if prices in both markets are known and if the profit outweighs the costs of the operation. Opportunities for arbitrage tend to be self-correcting, due to the increased demand for the commodity, there is an upward pressure on its price in the market where it is bought, whereas the increased supply in the market where it is sold results in a downward price movement.

Speculation Speculation refers to anticipating the movement of prices of a commodity for a future period. The anticipated movement may be a rise or a fall in the prices. Speculators are individuals and firms who seek to profit from anticipated increases or decreases in futures prices. In so doing, they help provide the risk capital needed to facilitate hedging. Introduction to agricultural commodities. The origin of agricultural commodity derivatives can be traced back to the need of farmers to protect themselves against fluctuations in the price of their crop. From the time it was sown to the time it was ready for 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.

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 over supply, he would have to dispose off his harvest at a very low price. Clearly this would mean 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 where by the price of the grain to be delivered in September could be decided earlier. What they would negotiate happened to be a futures-type contract which would enable both parties to eliminate the price risk.

The exchanges trades a number of agricultural commodities, among them four products are taken for analysis. They are: -

Chana

Maize

Soy bean

TurmericA brief introduction of the above products is given below: -Chana.

Chana belongs to the family of chickpea. Chana is the rabi crop and is cultivated form November - December to February March. Chana is the largest produced pulse in the world with a share of 50 percentages approximately. India is the largest producer and consumer of Chana in the world.

Present scenario.

Indias Chana production fluctuates between 5.5 to 7.5 million tons. The chart showing the production of Chana over the years is as follows.

The state wise contribution of Chana is as follows.

Indian Chana markets are highly fragmented, with long value chain. The major value chains are commission agents, brokers, stockiest, whole sale traders, dal mills and retail outlets. The information flow between these participants is restricted and very slow.Market influencing factors.

Weather plays a significant role in influencing the sentiments of the traders, and these sentiments have propounded impact on futures price.

The price of the other major pulses affects the price of Chana.

Price and yield of corresponding cash crops grown at the same time influence the supply.

Maize

Maize is one of the most important cereals of the world and provides more human food than any other cereal. Maize is of American origin having been domesticated about 7000 years ago. Maize provides nutrients for humans and animals and serves as a basic raw material for the production of starch, oil and protein, alcoholic beverages, food sweeteners and, more recently, fuel. Maize crop is grown in warm weather condition and it is grown in wide range of climatic conditions. About 85% of the total acreage under maize is grown during monsoon because of the fact that the crop stops growing if the night temperature falls below 15.60 C or 600 F.Present scenario.

India is the fifth largest producer of maize in the world contributing 3% of the global production.

Indias maize production has increased to more than 15 million tons today.

If we examine the production over the years, maize production in India is remained almost stagnant with constant yield levels despite rise in acreage.

The area brought under maize in India was 35.22 lakh hectares up from 27.36 lakh hectares planted during the corresponding period last year.

Market influencing factors.

Monsoon plays a significant role in influencing the sentiments of the traders, and these sentiments have propounded impact on futures price.

The EXIM policy of the Government regarding the maize affects the price changes.

Soybean

Soybean is the most economically important bean in the world. It is native of eastern Asia. Soy meal is the worlds most important vegetable protein feed source accounting nearly 65% of the world protein feed demand. About 98% of soy meal is used as an animal feed ingredient, with the remainder used in human foods such as bakery ingredients and meat substitutes. Soybeans, on crushing and solvent extraction, yield 17 18% soy oil and 82 83% soy meal. About 85% of the global soy bean production is crushed.

Present scenario

India produces 6 7 million tonnes of beans, 1 million tonne of oil, and 4 5 million tones of soy meal in a normal year.

Madhya Pradesh, Maharashtra, and Rajasthan are the major producers of Soy bean in India.

There are no imports of soybean into India as it is feasible to import oil. With imports, the total soybean oil availability in the country is around 2.8 million tons.

Factors influencing the market

Since growing areas are rain-dependent, the erratic monsoon affects the production and quality to a large extent.

The area planted is determined by the price of soybean against that of the competitive crops: maize, jowar, and bajra.

The international price movement and the futures market at CBOT are the major international reference markets. The government support prices play an important role.

The market is also affected by the crush margin among meal, oil, and seed.

Turmeric

Turmeric is a very important spice in India from ancient times. Turmeric, basically a tropical plant of ginger family is the rhizome or underground stem, with a rough, segmented skin. India produces nearly whole worlds turmeric crop and consume 80% of it. With its inherent qualities, Indian turmeric is considered the best in the world. The fresh spice is much preferred to the dried in South East Asia, the fresh rhizome is grated and added to curry dishes; it is also used as yellow curry paste in Thailand. Due to Indian influence, turmeric has also made its way to the cuisine of Ethiopia. Besides flavoring food, to purify the blood and purify the blood and remedy skin conditions is the most common use of turmeric in Ayurveda.

Present scenario.

India is the largest producer of turmeric in the world. Its production accounts for nearly 90% 0f the worlds turmeric production.

India is the largest exporter of turmeric in the world.

Tamil Nadu is the largest producer of turmeric in the country. Its production accounts for nearly 18% followed by Orissa.Market influencing factors

The international price movement and the futures market at CBOT are the major international reference markets. The government support prices play an important role.

Price and yield of corresponding cash crops grown at the same time influence the supplyTechnical analysis in commodity markets. Technical analysis involves a study of market-generated data like prices and volumes to determine the future direction of price movements. Simply put, technical analysis is the study of prices, with charts being the primary tool. The roots of modern-day technical analysis stem from the Dow theory developed around 1900 by Charles Dow. Stemming either directly or indirectly from the Dow Theory, these roots include such principles as the trending nature of prices, prices discounting all known information, confirmation and divergence, volume mirroring changes in price, and support/resistance. And of course, the widely followed Dow Jones Industrial Average is a direct offspring of the Dow Theory.

Technical analysts, called "chartists", may employ models and trading rules based on price and volume transformations, such as the relative strength index, moving averages, regressions, inter-market and intra-market price correlations, cycles or, classically, through recognition of chart patterns.

Technical analysis stands in distinction to fundamental analysis. Technical analysis "ignores" the actual nature of the company, market, currency or commodity and is based solely on "the charts," that is to say price and volume information, whereas fundamental analysis does look at the actual facts of the company, market, currency or commodity. The fundamental analysts believe that the market is 90 percentage logical and 10 percentage psychological. The technical analysts believe that it is 90 percentage psychological and 10 percentage logical. Technical analysts dont evaluate a large number of fundamental factors relating to the company or a commodity or economy. Instead they analyze internal market data with the help of charts and graphs.Assumptions

The Market Discounts Everything

Price Moves in Trends History Tends To Repeat Itself Market value of a scrip is determined by the demand and supply.Technical tools There are various technical tools used by the technical analysts to determine movement of the markets. Some of those are: -

Line charts

Simple Moving Average Analysis

Relative Strength Index (RSI):

Rate of Change (ROC)

Support and Resistance LevelA brief description of the above techniques is as follows: -

Line charts

A line chart shows the line connecting successive closing prices. Technical analysts believe that certain formations or patterns observed on the line chart have predictive value. The more important formations and their indications are: -

Head and shoulders top representing a bearish development.

Inverse Head and Shoulders Top reflecting the bullish development.

Triangle or Coil Formation represents the pattern of uncertainty.

Flags and Pennants Formation signifies a pause after which the previous price trend is likely to continue.

Double top formation represents a bearish development, signaling that the price is expected to fall.

Double bottom formation reflects a bullish development, signaling that the price is expected to rise.

Simple Moving Average Analysis Moving average is one of the oldest and most popular technical analysis tools. A moving average is the average price of a share over a given time. It is not a single number, but it is a set of numbers, each of which is the average of the corresponding subset of a larger set of data points.

A simple moving average is calculated by adding the share prices of the most recent n time periods and then dividing by n. For instance, adding the closing prices of a share for most recent 10 days and then dividing by 10. When calculating successive values, a new value comes into the sum and an old value drops out.

p + p1+ p2 + p3 + p4 +p5 + p6 + p7 +p8 + p9

SMA =

10

Cues to sell

Stock price line falls through the moving average line when the graph of the moving average line is flattening out.

Stock price line rises above the moving average line which is falling.

Stock price line, which is below the moving average line, rises but begins to fall again before reaching the moving average line.

Cues to buy

Stock price line rises through the moving average line when the graph of the moving average line is flattening out.

Stock price line falls below the moving average line, which is rising.

Stock price line, which is above the moving average line, falls but begins to rise again before reaching the moving average line.

Relative Strength Index (RSI):

The RSI is a financial technical analysis momentum oscillator measuring the velocity and magnitude of directional price movement by comparing upward and downward close-to-close movements. RSI can be calculated for a scrip by adopting the following formula.

Average Gain per Day

Rs =

Average Loss per Day

The RSI is calculated for 5, 7, 9 and 17 days. If the time period taken for calculation is more, the possibility of getting wrong signals is reduced.

Cues to sell

If the RSI touches 70

Cues to buy

If the RSI touches 30

Rate of Change (ROC)

The Rate of change (ROC) indicator measures the percentage change of the current price as compared to the price a certain number of periods ago. The ROC indicator can be used as a guide for determining overbought and oversold conditions. ROC displays the difference between the current price and price x-time periods ago. As prices increase, the ROC rises and as prices fall, the ROC falls. The 10-day ROC is an excellent short to intermediate term overbought/oversold indictor. The formula for rate of change is expressed bellow.

ROC = (Current price / Price n periods ago)*100

The main advantage of ROC is the identification of overbought and oversold region. The historic high and low values of the ROC should be identified at first to locate the overbought and oversold region. If the scrips ROC reaches the historic high values, the scrip is in the overbought region and a fall in the value can be anticipated. Likewise, if the scrips ROC reaches the historic low value, the scrip is in the oversold region, a rise in the scrips price can be anticipated. Investor can sell the scrip in the overbought region and buy it in the oversold region.

Cues to sell

If the ROC touches the overbought region

Cues to buy

If the ROC touches the oversold region

Support and Resistance Level.

A support level exists at a price where considerable demand for that stock is expected to prevent further fall in the price level. The fall in the price may be halted for the time being or it may result even in price reversal in the support level,demand for the particular scrip is expected.

In the resistence level,the supply of scrip would be greater than the demand and further rise in price is prevented. The selling pressure is greater and the increase in price is halted for the time being.

Cues to sell

If the prices touch the resistance level

Cues to buy

If the prices touch the support level

Chapter IIResearch design2.1 Title of the study

A STUDY ON COMMODITY MARKETS IN INDIA WITH REFERENCE TO AGRICULTURAL PRODUCTS

2.2 Problem statement

The commodity markets are more volatile in nature. The investors need to answer various questions like,

What commodity to buy?

What is the right time to buy and sell?

What is the risk involved?

Therefore the analysis of the commodity markets is not easy. It involves high complexity. Therefore a high degree of technical knowledge and expertise is required.

In this regard, the study provides a thorough understanding of the commodity markets. The study uses technical analysis as a tool to guide the investors to avoid the various risks and track the the commodity markets.

2.3 Review of Literature

Commodity Markets: New Investment Avenues - Arindam Banerjee The study traces the history of the commodity markets in India and examines the present scenario. The inception of Commodity Derivative markets in India started way back in 1875, with cotton being the first commodity to be traded. Trading in oilseeds followed this in 1900. The next to follow was forward trading in raw Jute and Jute goods in 1912. The volumes traded in those markets in the years cited were bleak and investor awareness was under scrutiny. Today, the scenario has changed radically and trading in commodities is considered to be the next biggest and the best in the investor fraternity. Commodities are such pervasive instruments that one cannot be a successful investor in other investment avenues such as stocks, bonds or even currencies, without a thorough understanding of them. Nowadays, commodities are being treated as a separate asset-class and primary among them are Gold and OilFacts and Fantasies about Commodity Futures - Gary Gorton The study focuses on the present scenario of the commodity futures and the differences between the commodity futures and other financial assets. Commodity futures are still a relatively unknown asset class, despite being traded in the U.S. for over 100 years and elsewhere for even longer. This may be because commodity futures are strikingly different from stocks, bonds, and other conventional assets. Some of the differences focused in the research are: -

Commodity futures are derivative securities; they are not claims on long-lived corporations

They are short maturity claims on real assets

Unlike financial assets, many commodities have pronounced seasonality in price levels and volatilities. Another reason that commodity futures are relatively unknown may be more prosaic, namely, there is a paucity of data.

Behavior of Market Prices of Agricultural Commodities - S R Takle

The article claims that the agricultural prices particularly of food grains and oilseeds play an important role in the whole national economy of India. They affect production decisions by the farmers and their incomes. Variations in prices of agricultural commodities are a big problem in Indian agriculture because of the dependence of production on monsoons. Agricultural prices exhibit spatial and temporal price fluctuations. Temporal price variations include seasonal, annual and long-term fluctuations. The article analyses the temporal price variation in food grains and oilseeds and makes suggestions to minimize the variation in prices of agricultural commodities in India.2.4 Objectives of the study To study the present scenario of the commodity markets.

To understand method of pricing agricultural commodity futures. To understand hedging, speculation and arbitrage in commodity futures.

To analyze agricultural commodities by using technical analysis.2.5 SCOPE OF THE STUDY

The study is confined to Indian commodity markets.

The study considers four agricultural commodities and the data collected from April 1st 2009 to March 31st 2010. National commodity and derivatives exchange limited

Multi commodity exchange of India limited.

National multi commodity exchange limited.2.6 Research methodology

The study uses both the primary and secondary sources to collect the data.

Types of data

Primary data

Professionals in the field Secondary data

Books Newspapers

Internet

Sample Design For the purpose of study, four agricultural products were randomly selected. The products are:

Chana

Maize

Soybean

TurmericData Analysis

The data collected was analyzed by using technical tools. The technical tools used are:

Line Chart

Simple Moving Average

Rate of Change

Relative Strength Index

Resistance and Support line 2.7 Operational definitions

Bear Market: A period of declining market prices.

Bull Market: A period of rising market prices. Cross-hedging: Hedging a commodity using a different but related futures contract when there is no futures contract for the cash commodity being hedged and the cash and futures markets follow similar price trends. For example, hedging cull cows on the live cattle futures market.

Delivery: The transfer of the cash commodity from the seller of a futures contract to the buyer of a futures contract.

In-the-Money Option: An option having intrinsic value. A call option is in-the-money if its strike price is below the current price of the underlying futures contract. A put option is in-the-money if its strike price is above the current price of the underlying futures contract.

Out-of-the-Money Option: An option with no intrinsic value, i.e., a call whose strike price is above the current futures price or a put whose strike price is below the current futures price. Intrinsic Value: The difference between the strike price and the underlying futures price for an option that is in-the-money.Long: One who has bought futures contracts or plans to own a cash commodity. Purchasing Hedge (long hedge): Buying futures contracts to protect against a possible price increase of cash commodities that will be purchased in the future. At the time the cash commodities are bought, selling an equal number and type of futures contracts as those that were initially purchased closes the open futures position.

Selling Hedge (short hedge): Selling futures contracts to protect against possible declining prices of commodities that will be sold in the future. At the time the cash commodities are sold, purchasing an equal number and type of futures contracts as those that were initially sold closes the open futures position.

Strike Price: The price at which the futures contract underlying a call or put option can be purchased (call) or sold (put). Also called exercise price.

Underlying Futures Contract: The specific futures contract that can be bought or sold by exercising an option.

Technical Analysis: Anticipating future price movements using historical prices, trading volume, open interest, and other trading data to study price patterns. 2.8 Limitations of the study.

The study is confining to historical price data. It provides only a gist, how the technical analysis could be used for the buy/hold/sell decision-making.

Due to the time constraint, the detailed study was not possible.

The commodity market is a vast subject so in-depth study was not possible. 2.9 CHAPTER SCHEME

1. Introduction This chapter provides a brief description of the commodities market in India, various commodities traded, and a special importance has been given to agricultural commodities.2. Research design The chapter includes the title of the study, statement of the problem, literature review objectives, scope and limitations of the study and chapter scheme.3. Profile of the Indian commodity markets This chapter provides the profile of the commodity market in India, its evolution, present scenario, regulation, and trends. The chapter also provides a brief profile of NCDEX, MCX and NMCE.4. Analysis and interpretation of data This chapter includes analysis and interpretation of data. The information collected is reduced to tables, graphs and charts.

5. Findings, suggestions and conclusion This chapter provides the various facts found during the study. The conclusion is given based on the findings and certain recommendations are made to the investors while investing in commodity markets.

Chapter III

Profile of the Indian commodity markets

Introduction

India is among the top 5 producers of most of the commodities, in addition to being a major consumer of bullion and energy products. Agriculture contributes about 22% to the GDP of the Indian economy. It employs around 57% of the labor force on a total of 163 million hectares of land. Agriculture sector is an important factor in achieving a GDP growth of 8%. All this indicates that India can be promoted as a major center for trading of commodity derivatives.

The Indian economy is witnessing a mini revolution in commodity derivatives and risk management. Commodity options trading and cash settlement of commodity futures had been banned since 1952 and until 2002 commodity derivatives market was virtually non-existent, except some negligible activity on an OTC basis. Now in September 2005, the country has 3 National level electronic exchanges and 21 regional exchanges for trading commodity derivatives. As much as 80 commodities have been allowed for derivatives trading. Evolution The evolution of the Indian commodity markets dates backs to the year 1875 when the Bombay Cotton Exchange was established. Today India has 24 Exchanges and more than 100 commodities traded. The development of Indian commodity markets can be studied under 3 periods. They are the pre-independence period, the post-independence period and the post-liberalization period. Pre-independence period

Bombay Cotton Trade Association Ltd., set up in 1875, was the first organized futures market.

Bombay Cotton Exchange Ltd. was established in 1893 following the widespread discontent amongst leading cotton mill owners and merchants over functioning of Bombay Cotton Trade Association. The Futures trading in oilseeds started in 1900 with the establishment of the Gujarati Vyapari Mandali, which carried on futures trading in groundnut, castor seed and cotton. Futures trading in wheat were existent at several places in Punjab and Uttar Pradesh. But the most notable futures exchange for wheat was chamber of commerce at Hapur set up in 1913. Calcutta Hessian Exchange Ltd. was established in 1919 for futures trading in raw jute and jute goods. Futures trading in bullion began in Mumbai in 1920. Organized futures trading in raw jute began in 1927 with the establishment of East Indian Jute Association Ltd. In 1945 to form the East India Jute & Hessian Ltd. to conduct organized trading in both Raw Jute and Jute goods. Several other exchanges were created in the country to trade in diverse commodities.

Post-independence period

The Parliament passed Forward Contracts (Regulation) Act, 1952 which regulated forward contracts in commodities all over India. The Act applies to goods, which are defined as any movable property other than security, currency and actionable claims.

The Act prohibited options trading in goods along with cash settlements of forward trades, rendering a crushing blow to the commodity derivatives market. Under the Act, only those associations or exchanges, which are granted recognition by the Government, are allowed to organize forward trading in regulated commodities.

The Exchange, which organizes forward trading in commodities, can regulate trading on a day-to-day basis.

The Forward Markets Commission provides regulatory oversight under the powers delegated to it by the central Government.

The Central Government - Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution - is the ultimate regulatory authority. The Forwards Markets Commission (FMC) was established in 1953 under the Ministry of Consumer Affairs and Public Distribution. In due course, several other exchanges were created in the country to trade in diverse commodities. The commodity derivatives market got a crushing blow in 1960s, following several years of severe draughts that forced many farmers to default on forward contracts.

Forward trading was banned in many commodities considered primary or essential. As a result, commodities derivative markets dismantled and went underground where to some extent they continued as OTC contracts at negligible volumes. In 1970s and 1980s the Government relaxed forward trading rules for some commodities.Post-liberalization period

After the Indian economy embarked upon the process of liberalization and globalization in 1990, the Government set up a Committee in 1993 to examine the role of futures trading. The Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in 17 commodity groups. It also recommended strengthening of the Forward Markets Commission, and certain amendments to Forward Contracts (Regulation) Act 1952, particularly allowing options trading in goods and registration of brokers with Forward Markets Commission. The Government accepted most of these recommendations and futures trading were permitted in all recommended commodities. The recommendations of the committee were as follows: The Forward Markets Commission (FMC) and the Forward Contracts (Regulation) Act, 1952, would need to be strengthened. Enlisting more members, ensuring capital adequacy norms and encouraging computerization would enable these exchanges to place themselves on a better footing. In-built devices in commodity exchanges such as the vigilance committee and the panels of surveyors and arbitrators be strengthened further. The FMC which regulates forward/ futures trading in the country, should continue to act a watchdog and continue to monitor the activities and operations of the commodity exchanges. Amendments to the rules, regulations and byelaws of the commodity exchanges should require the approval of the FMC only. Some of the commodity exchanges, particularly the ones dealing in pepper and castor seed, be upgraded to the level of international futures markets. The Committee recommended the futures trading in the commodities like Basmati rice, Cotton and Kapas, Raw jute and Jute goods, Groundnut, rapeseed/mustard seed, cottonseed, sesame seed, sunflower seed, Safflower seed, copra and soybean, and oils and oilcakes of all of them, Rice bran oil, Castor oil and its oil cake, Linseed, Silver, Onions.Present scenario The commodity market in India facilitates multi commodity exchange within and outside the country based on requirements. Commodity trading is one facility that investors can explore for investing their money. The India Commodity market has undergone lots of changes due to the changing global economic scenario; thus throwing up many opportunities in the process. Demand for commodities both in the domestic and global market is estimated to grow by four times than the demand currently is by the next five years. At present there are 24 commodity exchanges and more than 100 commodities are traded. Commodity markets have been in a bull trend. Some of the major drivers that have contributed in this stupendous growth of commodity markets are: -

Increasing influence of Asian demand, particularly from rapidly industrializing China and India.

Increase in commodities prices in international markets as a result of demand growth, reinforced by tight supply capacities, tense geopolitical conditions (especially with respect to the oil market) and intense speculative activity.

With the rise in prices of crude oil, metals and minerals, commodity prices reached record historical levels in nominal terms in 2006, which increased by more than 30% between 2005 and 2006 (and by 80% from 2000 to 2006). The considerable rise in prices has had an impact on incomes of developing countries. It is estimated that extra revenues resulting from commodity exports were around 6.7 percentage points of GDP for oil-exporting countries and about 3 percentage points for countries exporting mining products. Increases in demand from developing countries stimulated by a particularly vigorous commodity consumption per unit of GDP compared to that of developed countries, faster economic growth, and increasing population.

"Globalization" of securities and commodities markets.

Baby boomers are in the middle of their peak savings years and have been one of the major causes of huge inflows of money into the stock market and into mutual funds. The increased use of food crops for production of bio-fuels is an important factor that led to large increases in the prices of vegetable oils and grains in 2007, which in turn contributed to an overall 15 percent increase in the index of agricultural prices and a 20 percent rise in food prices. The prices of metals have increased more than other commodity prices over the last four years, largely because of an especially strong demand in China. Shortages of equipment and skilled workers have significantly increased development costs, and ore grades are deteriorating.Regulation of commodity markets in India At present, there are three tiers of regulations of forward/futures trading system in India, namely:-

Government of India.

Forward Markets Commission (FMC).

Commodity exchanges.

The need for regulation arises on account of the fact that the benefits of futures markets accrue in competitive conditions. Proper regulation is needed to create competitive conditions. In the absence of regulation, unscrupulous participants could use these leveraged contracts for manipulating prices. This could have undesirable influence on the spot prices, thereby affecting interests of society at large. Regulation is also needed to ensure that the market has appropriate risk management system. In the absence of such a system, a major default could create a chain reaction. The resultant financial crisis in a futures market could create systematic risk. Regulation is also needed to ensure fairness and transparency in trading, clearing, settlement and management of the exchange so as to protect and promote the interest of various stakeholders, particularly nonmember users of the market.

Rules governing the Commodity Exchanges

The Stock Exchanges have been governed by two kinds of rules. First, the rules framed by the Forward Markets Commission and the rules indicated in the Forward Contracts (Regulation) Act, 1952. A brief description of these rules are given below.The FMC prescribes the following regulatory measures to Exchanges: Limit on net open position as on the close of the trading hours. Some times limit is also imposed on intraday net open position. The limit is imposed operatorwise, and in some cases, also member wise Circuitfilters or limit on price fluctuations to allow cooling of market in the event of abrupt up swing or downswing in prices. Special margin deposit to be collected on outstanding purchases or sales when price moves up or down sharply above or below the previous day closing price. By making further purchases/sales relatively costly, the price rise or fall is sobered down. This measure is imposed only on the request of the exchange. Circuit breakers or minimum/maximum prices: These are prescribed to prevent futures prices from falling below as rising above not warranted by prospective supply and demand factors. This measure is also imposed on the request of the exchanges. Skipping trading in certain derivatives of the contract, closing the market for a specified period and even closing out the contract: These extreme measures are taken only in emergency situations.Rules framed by Forward Contracts (Regulation) Act, 1952 towards Exchanges: The trading in commodities notified under section 15 of the Act can be conducted only on the exchanges, which are granted recognition by the central government. All the exchanges, which deal with forward contracts, are required to obtain certificate of registration from the FMC. All the exchanges are subjected to various laws of the land like the Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and various other legislations, which impinge on their working.

Rules governing the Intermediaries

The Exchanges provides an automated trading facility in all the commodities admitted for dealings on the spot market and derivative market. Trading on the exchange is allowed only through approved workstations located at locations for the office of a trading member as approved by the exchange. Each trading member is required to have a unique identification number which is provided by the exchange and which will be used to log on to the trading system.

A trading member has a nonexclusive permission to use the trading system as provided by the exchange in the ordinary course of business as trading member. Trading members have to pass a certification program, which has been prescribed by the exchange. In case of trading members, other than individuals or sole proprietorships, such certification program has to be passed by at least one of their directors/ employees/ partners / members of governing body.

Each trading member is permitted to appoint a certain number of approved users as notified from time to time by the exchange.

The trading member or its approved users are required to maintain complete secrecy of its password. Any trade or transaction done by use of password of any approved user of the trading member, will be binding on such trading member. Approved user shall be required to change his password at the end of the password expiry period.

The exchange operates on all days except Saturday and Sunday and on holidays that it declares from time to time.

The exchange announces the normal trading hours/ open period in advance from time to time. In case necessary, the exchange can extend or reduce the trading hours by notifying the members. Trading cycle for each commodity/ derivative contract has a standard period, during which it will be available for trading.

Derivatives contracts expire on a predetermined date and time up to which the contract is available for trading. This is notified by the exchange in advance. The contract expiration period will not exceed twelve months or as the exchange may specify from time to time.

In the event of a default by the seller or the buyer in delivery of commodities or payment of the price, the exchange closes out the derivatives contracts and imposes penalties on the defaulting buyer or seller, as the case may be.

Delivery in respect of all deals for the clearing in commodities happens through the depository clearing system. The delivery through the depository clearing system into the account of the buyer with the depository participant is deemed to be delivery, notwithstanding that the commodities are located in the warehouse along with the commodities of other constituents.

Payment in respect of all deals for the clearing has to be made through the clearing banks.

The exchange specifies from time to time the delivery units for all commodities admitted to dealings on the exchange.

Every clearing member must have a clearing account with any of the Depository Participants of specified depositories.

Rules governing the investors grievances, arbitration.

In matters where the exchange is a party to the dispute, the civil courts at Mumbai have exclusive jurisdiction and in all other matters, proper courts within the area covered under the respective regional arbitration center have jurisdiction in respect of the arbitration proceedings falling/ conducted in that regional arbitration center. If the value of claim, difference or dispute is more than Rs.25 Lakh on the date of application, then such claim, difference or dispute are to be referred to a panel of three arbitrators. If the value of the claim, difference or dispute is up to Rs.25 Lakh, then they are to be referred to a sole arbitrator.Tools for regulation.

Limits on speculative open position Price limits MTM Gross upfront margining Special margins

NATIONAL COMMODOTY AND DERIVATIVES EXCHANGE LIMITED (NCDEX)

National Commodity & Derivatives Exchange Limited (NCDEX) is a professionally managed on-line multi commodity exchange. The shareholders of NCDEX comprises of large national level institutions, large public sector banks and companies. NCDEX is a public limited company incorporated on April 23, 2003 under the Companies Act, 1956. It obtained its Certificate for Commencement of Business on May 9, 2003. It commenced its operations on December 15, 2003.

Forward Markets Commission regulates NCDEX in respect of futures trading in commodities. Besides, NCDEX is subjected to various laws of the land like the Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and various other legislations, which impinge on its working. It is located in Mumbai and offers facilities to its members in about 91 cities throughout India at the moment.Promoters

ICICI Bank Limited, Life Insurance Corporation of India (LIC), National Bank for Agriculture and Rural Development (NABARD) and National Stock Exchange of India Limited (NSE).

Other shareholders:

Canara Bank, Punjab National Bank (PNB), CRISIL Limited, Indian Farmers Fertilizer Cooperative Limited (IFFCO), Goldman Sachs, Intercontinental Exchange (ICE) and Shree Renuka Sugars.Capital structure:ParticularsEquity

(Rs. in crores)Preference

(Rs. In crores)Total

(Rs. In crores)

Authorized capital601070

Issued & Subscribed capital301040

Board of directors

The shareholders holding stake of 10% or more have their representatives on the Board of the Exchange. The Board of Directors comprises 8 Directors who are well known, highly experienced and are independent. The Managing Director is the only whole-time Director. Mr. B. V. Bhargava is the non-executive Chairman of the Board. Mr. R. Ramaseshan is the Managing Director and Chief Executive Officer

The Trading system The trading system of NCDEX comprises of three divisions. Namely trading, clearing and settlement. A brief description is given below.

Trading

The trading system on the NCDEX provides a fully automated screenbased trading for futures on commodities on a nationwide basis as well as an online monitoring and surveillance mechanism. It supports an order driven market and provides complete transparency of trading operations. The trade timings of the NCDEX are 10.00 a.m. to 4.00 p.m.

The NCDEX system supports an order driven market, where orders match automatically. Order matching is essentially on the basis of commodity, its price, time and quantity. All quantity fields are in units and price in rupees. The exchange specifies the unit of trading and the delivery unit for futures contracts on various commodities. The exchange notifies the regular lot size and tick size for each of the contracts traded from time to time. When any order enters the trading system, it is an active order. It tries to find a match on the other side of the book. If it finds a match, a trade is generated. If it does not find a match, the order becomes passive and gets queued in the respective outstanding order book in the system. Time stamping is done for each trade and provides the possibility for a complete audit trail if required. NCDEX trades commodity futures contracts having onemonth, twomonth and three month expiry cycles. All contracts expire on the 20th of the expiry month. Clearing

National Securities Clearing Corporation Limited (NSCCL) undertakes clearing of trades executed on the NCDEX. The settlement guarantee fund is maintained and managed by NCDEX. Only clearing members including professional clearing members (PCMs) are entitled to clear and settle contracts through the clearing house.

At NCDEX, after the trading hours on the expiry date, based on the available information, the matching for deliveries takes place. Firstly, on the basis of locations and then randomly, keeping in view the factors such as available capacity of the vault or warehouse, commodities already deposited and dematerialized and offered for delivery etc. Matching done by this process is binding on the clearing members. After completion of the matching process, clearing members are informed of the deliverable or receivable positions and the unmatched positions. Unmatched positions have to be settled in cash. The cash settlement is only for the incremental gain or loss as determined on the basis of final settlement price.Settlement

Futures contracts have two types of settlements, the MTM settlement, which happens on a continuous basis at the end of each day, and the final settlement, which happens on the last trading day of the futures contract.

On the NCDEX, daily MTM settlement and final MTM settlement in respect of admitted deals in futures contracts are cash settled by debiting or crediting the clearing accounts of CMs with the respective clearing bank. All positions of a CM, brought forward, created during the day or closed out during the day, are market to market at the daily settlement price or the final settlement price at the close of trading hours on a day. On the date of expiry, the final settlement price is the spot price on the expiry day. The responsibility of settlement is on a trading cum clearing member for all trades done on his own account and his clients trades.

NATIONAL MULTI COMMODITY EXCHANGE (NMCE)

National Multi Commodity Exchange of India Ltd. (NMCE) was the first such exchange to be granted permanent recognition by the Government. National Multi-Commodity Exchange of India Limited, the first De-Mutualised Electronic Multi-Commodity Exchange granted the national status on a permanent basis by the government of India and operational since 26th November 2002.

In April 1999 the Government took a landmark decision to remove all the commodities from the restrictive list. Food-grains, pulses and bullion were not exceptions. The long spell of prohibition had stunted growth and modernization of the surviving traditional commodity exchanges. Therefore, along with liberalization of commodity futures, the Government initiated steps to cajole and incentives the existing Exchanges to modernize their systems and structures. Faced with the grudging reluctance to modernize and slow pace of introduction of fair and transparent structures by the existing Exchanges, Government allowed setting up of new modern, demutualised Nation-wide Multi-commodity Exchanges with investment support by public and private institutions. National Multi Commodity Exchange of India Ltd. (NMCE) was the first such exchange to be granted permanent recognition by the Government.

Promoters

Punjab National Bank, Gujarat State Agricultural Marketing Board, Neptune Overseas Limited, Reliance Money, National Institute of Agricultural Marketing.

Management

Shri. B. B. Pattanaik, is Chairman of the Board of Directors

Shri. Kailash. R. Gupta - Managing Director

The Trading System

Benefits of futures market, viz., price discovery and price risk management flow more easily from an Order-driven system rather than Quote-driven system. NMCE follows the former system. NMCE does not support any market maker. Traders submit orders and the incoming orders are matched against the existing orders in the order book.

Transactions are cleared and settled through NMCEs in-house Clearing and Settlement House, which is connected to all its Members and the Clearing Banks. Delivery of the underlying commodities is permitted only through a Central Warehousing Corporation (CWC) receipt, which meets highest contemporary international standards. Anonymity of trading participants and effective risk management system strengthens the trust of the participants in the trading system, which is a precondition for enhancing breadth and depth of the market. Trading Cum Clearing Member (TCM): Is one who has the right to execute transactions in addition to a right to clear its transactions in contracts executed at NMCE either on his own behalf or on behalf of other Trading Members. Trading Member/Broker (TM): Is one who has the right to execute transactions in the trading system of the exchange and the right to have contracts in his own name. The TM can also deal on behalf of clients (Registered Non Members) or enlist Sub Brokers who may in turn have their own set of clients. Institutional Clearing Members (ICMs): Are professional entities providing clearing services to their institutional clients. They however do not have the right to trade on their own account. Simply put, participants trade in any market to make money. If transactions costs are high, there will be less incentive to trade. Notwithstanding the distinctive advantages NMCE offers to its customers, it has not lost sight of the need to provide membership as well as trading, clearing and settlement facilities at lowest possible cost. To this end, the exchange has not only acquired technology at lowest cost going by global standards, but has also put in place effective cost cutting strategies to minimize non-capital expenditure. The uniqueness of its business model as well as cost structure provides clear competitive advantage to NMCE over other comparable Indian Exchanges Multi Commodity Exchange (MCX) Multi Commodity Exchange of India Ltd is a demutualised nationwide electronic commodity futures exchange set up by Financial Technologies (India) Ltd. with permanent recognition from Government of India for facilitating online trading, clearing & settlement operations for futures market across the country. The exchange started operations in November 2003.

MCX has achieved three ISO certifications including ISO 9001:2000 for quality management, ISO 27001:2005 - for information security management systems and ISO 14001:2004 for environment management systems. MCX offers futures trading in more than 40 commodities from various market segments including bullion, energy, ferrous and non-ferrous metals, oil and oil seeds, cereal, pulses, plantation, spices, plastic and fibre. The exchange strives to be at the forefront of developments in the commodities futures industry and has forged strategic alliances with various leading International Exchanges, including Tokyo Commodity Exchange, London Metal Exchange, New York Mercantile Exchange, Bursa Malaysia Derivatives, Berhad and others.

PromoterFinancial Technologies (India) LtdOther shareholders

NYSE Euronext, State Bank of India and its associates (SBI), National Bank for Agriculture and Rural Development (NABARD), National Stock Exchange of India Ltd. (NSE), SBI Life Insurance Co. Ltd., Bank of India (BOI), Bank of Baroda (BOB), Union Bank of India, Corporation Bank, Canara Bank, HDFC Bank, Fid Fund (Mauritius) Ltd. - an affiliate of Fidelity International, ICICI Ventures, IL&FS, Kotak group, Citi Group and Merrill Lynch. Board of directors

Mr. Venkat Chary Chairman.

Mr. Jignesh Shah - Vice Chairman.

Mr. Lambertus Rutten - Managing Director & CEO.

8 Independent Directors

4 Non Executive directors

Trading System

The best five buy and sell orders for every contract available for trading are visible to the market and orders are matched based on price time priority logic. Orders can be placed with time conditions and/ or price conditions. Time related Conditions DAY order- A Day order is valid for the day on which it is entered. If the order is not matched during the day, the order gets cancelled automatically at the end of the trading day. GTC - A Good Till Cancelled (GTC) order is an order that remains in the system until the expiry of the respective contract in which it is entered or until when the same is cancelled by the member. GTD - A Good Till Date (GTD) order is valid till the date specified by the member. After the specified date the system automatically cancels the unexecuted orders. IOC - An Immediate or Cancel (IOC) order allows a member to execute the orders as soon as the same is placed in the market, failing which the order will get cancelled immediately Price Conditions Limit Order The order wherein the price is to be specified while placing the same. Market Order The order at the best available price at the time of placing the same.

Margins

MCX follows a comprehensive and stringent margining system for all future contracts traded on the Exchange platform. Actual margining and position monitoring is done on an on-line basis. For the purpose of computing and levying the margins, MCX uses SPAN (Standard Portfolio Analysis of Risk) system which follows a risk-based and portfolio-based approach. The Initial Margin requirement is based on a worst-case loss scenario of portfolio at client level to cover VaR (value at Risk) over a one-day horizon, subject to a minimum Base Margin defined by FMC for the respective commodity.

The SPAN Risk Parameter File (RPF) is generated by the Exchange periodically at pre-defined timings and RPF files so generated are provided to the members using the FTP service and on the Exchange website. In addition to SPAN margins, MCX levies Additional margins and/ or Special margins whenever deemed necessary considering the volatility and price movement in the commodities. Such margins are also levied as per the directions of FMC Tender Period margins and Delivery Period Margins are levied on contracts nearing expiry to ensure non-default in commodity delivery.Trends in commodity markets. With the advancement of Internet technology in the recent years commodity futures trading has become entirely possible without the interaction of a commodity broker. The number of commodity futures traded has increased gradually. In India at present more than 100 commodities are traded. The yellow metal gold is trading at its high.

The oil prices soaring.

Farmers facing price and volume risks due to uncertain rainfall.

Speculation in forward markets has increased.

Chapter IV

Data analysis and interpretation To understand the pricing of agricultural commodity futures. To understand the futures prices on agricultural commodities, first we need to understand the arbitrage arguments. Consider the following case:-

The spot market rate of turmeric is Rs.11,200 per quintal. The rate of interest available is at 8%. Verify the arbitrage opportunities,

If the three months futures price of turmeric is Rs.11,800 per quintal. If the three months futures price of turmeric is Rs.11,000 per quintal.If the three months futures price of turmeric is Rs.11,800 per quintal In this case the arbitrager borrows Rs.11,200 at 8% p.a., buys the turmeric in the spot market. Simultaneously sell the three months futures contract at Rs.11,800 per quintal.

At the end of three months, the arbitrager delivers turmeric and receives Rs.11,800 per quintal.

The interest and principal the arbitrager need to pay is Rs.11,424. By following this strategy, the arbitrager locks in a profit of Rs.376 per quintal (Rs.11,800 Rs.11,424) at the end of three months.

If the three months futures price of turmeric is Rs.11,000 per quintal. In this scenario, the arbitrager shorts turmeric at Rs.11,200 in the spot market, invest it at the rate of 8% p.a. for three months. Simultaneously takes a long position in three months futures contract on turmeric at Rs.11,000 per quintal. At the end of three months, the sale proceeds of turmeric grows to Rs.11,424. The arbitrager pays Rs.11,000 and takes the delivery of turmeric. The arbitrager by following this strategy makes a profit of Rs.224 per quintal.

So the effective futures price is: - The arbitrage exists when the futures price of turmeric is more than Rs.11,424 per quintal and also when the futures price is less than Rs.11,424 per quintal. But there is no arbitrage at Rs.11,424 per quintal. Therefore, Rs.11,424 per quintal is the effective futures price of a three months turmeric contact.

As seen above, the agricultural commodities are priced based on the arbitrage arguments. The commodity is priced at a point where there is no opportunity for arbitrage.Table 4.1

The affect of arbitrage on pricing

Spot price (Rs.)Future price (Rs.)Interest (Rs.)Interest & principal (Rs.)Arbitrage (Rs.)

11,20011,80022411,424376

11,20011,00022411,424224

11,20011,42422411,4240

To understand Hedging, speculation and arbitrage in commodity futures.

Hedging Long hedge in commodity futures.

The long hedge in the commodity market is done to reduce the price risk, which could arise in the commodities.

Consider the case, a cattle feed manufacturer needs maize to manufacture cattle feed. He knows that he have to buy 100 MT of maize in four months from now. On April 1st 2010, The spot price of Maize at Davangere was Rs.902 per quintal. The July 2010 contract was trading at Rs.931 per quintal on NCDEX.Table 4.2

The contract specification of MaizeTrading systemNCDEX trading system

Trading hoursMondays through Fridays: 10.00 am to 5.00 pm

Saturdays: 10.00 am to 2.00 pm

Unit of trading10 MT

Delivery unit10 MT

Quotation or base valueRs. Per quintal

Tick size50 paisa

In this scenario, the manufacturer buys 10 future contracts of 10 MT on NCDEX at a price of RS.931 per quintal. On the expiry, the spot price may be more than Rs.931 per quintal or less than that. Now let us understand how this works.

If the spot price exceeds Rs.931 per quintal Assume in the month of July the spot price of Maize at Davangere has risen to Rs.945 per quintal. The manufacturer pays Rs.9,45,000 to buy Maize from spot market. Because July is the month of futures contract, the future prices should be very close to spot prices of Rs.945 per quintal. Now the manufacturer closes his long futures position at Rs.945 making a gain of Rs.14 per quintal or Rs.14000 on its long futures position. The effective cost of Maize purchased works out to be about Rs.931 per quintal or Rs.9,31,000.

If the spot price falls below Rs.931 per quintal Assume the spot prices at Davangere fell down to Rs.925 per quintal in July. The manufacturer pays Rs. 9,25,000 to buy 100 MT of Maize at spot market and since July is the month for the future contracts to expire, the futures price should be very close to the spot price of Rs.925 per quintal. The manufacturer closes his long position at Rs.925 making a loss of Rs.6 per quintal or Rs.6000 in its long futures position. The effective cost of purchasing maize works out to be about Rs.931 per quintal or Rs.9,31,000 in total.Short hedge in commodity futures

A short hedge is appropriate when the hedger already owns the asset, or is likely to own the asset and expects to sell it at some time in the future. A short hedge is used in reducing the price risk associated with selling an output.

Consider the following case. The producer of turmeric knows that he will be selling 50 MT of turmeric four months from now. On 1st April 2010, turmeric was selling at Rs.11,514 a quintal at Nizamabad. The July 2010 turmeric future contract was selling at Rs.10879 on NCDEX platform.

Table 4.3

Contract specification of TurmericTrading systemNCDEX trading system

Trading hoursMondays through Fridays: 10.00 am to 5.00 pm

Saturdays: 10.00 am to 2.00 pm

Unit of trading10 MT

Delivery unit10 MT

Quotation or base valueRs. Per quintal

Tick sizeRe.1

In this scenario, the producer sells 5 turmeric future contracts, at Rs.10879, which will expire in the month of July. On the expiry the spot price may be more than future price or less than future price. Now let us understand how this works.

If the spot price exceeds Rs.10,879 per quintal Assume that the spot price on expiry is Rs.11000 a quintal. The producer realized Rs.55,00,000 under his sale contract. Because July is the delivery month of futures contract, the futures price in July should be very close to the spot price of Rs.11,000 per quintal. Now the producer closes his short futures position at Rs.10879 by making a loss of Rs.121 per quintal or Rs.60500 on its short futures position. The total amount realized from both the futures position and the sale contract is therefore about Rs.10879 per quintal or Rs.54,39,500.

If the spot price falls below Rs.10,879?

Assume that the spot price is Rs.10700 per quintal. The producer realizes Rs.53,50,000 under his sale contract. Because July is the delivery month for futures contract, the futures price in July should be very close to the spot price of Rs.10,700 per quintal.

The producer closes his short position at Rs.10,879 per quintal making a profit of Rs.179 per quintal or Rs.89500 on its short future position. The total amount realized from both the futures position and the sales contract is about Rs.10879 or Rs.54,39,500 in total.

Therefore the purpose of hedging is not to make profits, but to lock on to a price to be paid in the future upfront. In the above cases, we assume that the futures position is closed out in the delivery month.Speculation in commodity futures Basically there are two important strategies used by the speculators in the commodity futures markets. Let us analyze the strategies in detail.If the commodity is bearish Consider the case of a speculator who has a clear view of movements of prices of Maize. At present Maize is selling at Rs.900 and he speculates that due to sufficient monsoon, the supply of Maize is going to rise in the near future and hence the price is going to fall.

In this scenario, the speculator has to sell the Maize future contract. Simple arbitrage ensures that the price of a futures contract on a commodity moves correspondingly with the price of the underlying commodity. If the commodity price rises, so will the futures price. If the commodity price falls, so will the futures price. Now the trader sells 10 three months futures contract which is for the delivery of 10 MT of Maize. The value of future contract is Rs.930 per quintal or Rs.9,30,000 in total. After three months if the speculator is correct the prices should fall. Assume the prices fell to Rs.920 per quintal. Now the speculator closes his short position at Rs.9,20,000 making a gain of Rs.10,000.

So from the above case it is clear that if the commodity is bearish a speculator has to sell the futures.If the commodity is bullish

On April 1st 2010 the Chana was trading at Rs.2291 at Delhi spot market. The July 2010 future contract is trading at Rs. 2522 per quintal at NCDEX.Table 4.4

Contract specification of ChanaTrading systemNCDEX trading system

Trading hoursMondays through Fridays: 10.00 am to 5.00 pm

Saturdays: 10.00 am to 2.00 pm

Unit of trading10 MT

Delivery unit10 MT

Quotation or base valueRs. Per quintal

Tick sizeRe.1

In this scenario the speculator has to buy the futures.

Assume that the speculator bought the three-month futures for delivery of 50 MT at a price of Rs.2522 per quintal or Rs.12,61,000. After three months if the speculator is correct the prices should go up. Assume that the prices rised to Rs.2600 per quintal. The trader closes his long position at Rs.2600 per quintal making of Rs.78 per quintal or Rs.39,000.Arbitrage If the commodity futures are overpriced Assume that the gold is trading at Rs.16300 per 10gms in the spot market at Ahmedabed on 10th April 2010.

On the same date the three month futures is trading at Rs.16800 per 10gms at NCDEX and seems overpriced. Table 4.5

The contract specification of soybean Trading systemNCDEX trading system

Trading hoursMondays through Fridays: 10.00 am to 5.00 pm

Saturdays: 10.00 am to 2.00 pm

Unit of trading1 kg

Delivery unit1 kg

Quotation or base valueRs. Per 10gms

Tick sizeRe.1

In this scenario, the arbitrageur borrows Rs.81,53,885 at 8% per annum and buys 5 kgs of gold in the spot market at Rs.. Pays 3885 as costs. (we assume Rs.310 as fixed cost per deposit upto 500 kgs. and the variable storage costs are Rs.55 per kg per week for 13 weeks). Simultaneously, sell 5 three-months gold futures contracts at Rs.8400000. On the date of expiry, say the spot market rate is Rs.16,750 per 10gms. Sell the gold for Rs.83,75,000. The futures will expire with a profit of Rs. 25000 ( Rs.16800-16750 per 10gms for 5 contracts) From Rs. 84,00,000 in hand, return the borrowed amount plus interest of Rs.163077. The result is a profit of Rs.83,037 If the commodity futures are underpriced

Assume that the gold is trading at Rs.16300 per 10gms in the spot market at Ahmedabed on 10th April 2010. On the same date the three month futures is trading at Rs.16400 per 10gms and seems overpriced.

In this scenario, the arbitrageur has to sell 5kgs of gold at Rs.16,300 per 10gms. The total amount comes to Rs.81,50,000.

Invest Rs.81,50,000 and Rs.3885 at 8% interest per annum.

Buy three-months gold futures at NCDEX for Rs.82,00,000.

On the date of expiry the spot price and the futures price converge. Assume the gold price is Rs. 16,500 per 10gms.

By this time, the sale proceeds of gold has grown to Rs.83,16,962 with an interest gain of Rs.1,63,077.

The futures position will expire with a profit of Rs.50000 (16500-16400 for 10gms).

Buy back 5kgs of gold in the spot market for Rs.82,50,000 (Rs.16,500 per 10gms)

The result is a profit of Rs.1,16,962 (Rs.83,16,962 - 82,50,000 per 10gms = Rs.66962 + 50,000)

Analysis of agricultural products by using technical tool

Table 4.6The NCDEX spot prices (in Rs.) from 1st April 2009 to 31st March 2010

DateChanaMaizeSoybeanTurmeric

01-Apr-0923468482363.55502

02-Apr-092381855.52422.55513

03-Apr-0924278692443.55586

04-Apr-092497867.52482.55627

06-Apr-092540869.525325575

07-Apr-092540869.525325575

08-Apr-0925288682541.55457

09-Apr-09257486826015425

11-Apr-0925618892637.55611

13-Apr-0925548742580.55646

14-Apr-0925548742580.55646

15-Apr-092528874.52649.55639

16-Apr-092540881.526255414

17-Apr-0925908812727.55342

18-Apr-0926088832747.55131

20-Apr-0925768872733.55337

21-Apr-0925988832801.55334

22-Apr-09263491628795451

23-Apr-0926369082867.55394

24-Apr-0926038932822.55249

25-Apr-09258988827535312

27-Apr-09251286626435138

28-Apr-09251585326345129

29-Apr-092521849.526545200

01-May-092521849.526545200

02-May-0925458772760.55361

04-May-092502878.52840.55456

05-May-092482867.528195436

06-May-092483862.52798.55507

07-May-092488867.527995480

08-May-092462857.527545452

11-May-0924678602717.55274

12-May-092460862.52743.55417

13-May-092451860.527595361

14-May-09242885627245415

15-May-09242886027385357

16-May-092461866.527465395

18-May-09244085026955441

19-May-092416857.52696.55447

20-May-092419870.52697.55450

21-May-09238397126235582

22-May-092345938262