Page 268 - DCOM507_STOCK_MARKET_OPERATIONS

Unit 13: Commodity Market

13.4.1 Need for an Exchange-traded Commodity Derivatives Market Notes

The biggest advantage of having an exchange-based platform is the reach. A wider reach ensures
greater participation, which results into a more efficient price discovery mechanism. In fact, it
comes to a stage where the derivative market guides the spot market in terms of pricing.

Example: Imagine a soya wholesaler in Madhya Pradesh who, having bought the crop
from the farmer, wishes to sell it to the oil refiners. To sell his crop he has to go to the local
market at Indore. The price that he will get for his crop would be solely dependent upon the
demand supply condition prevailing at that point of time at that market place. Also, as the
number of players is less, there are chances of the prices being biased. In contrast, the prices in
the futures market are determined not only by the local demand supply conditions but also by
the global scenario. Add to that the view taken on a commodity by various sets of people
depending upon different parameters such as technical analysis, political news, exchange rates
etc. The price that is, thus, quoted can be safely regarded as the most efficient price.
13.4.2 Opportunities the Commodity Derivatives Provide for Investors

Futures contract in the commodities market, similar to equity derivatives segment, will facilitate
the activities of speculation, hedging and arbitrage to all class of investors.

Speculation: It facilitates speculation by providing opportunity to people, although not involved
with the commodity, to trade on the views in the movement of commodity prices. The speculative
position is taken with a small margin amount that is paid to the exchange, and the contract can
be squared-off anytime during the trading hours.
Hedging: For the people associated with the commodities, the futures market can provide an
effective hedging mechanism against price movements.
For example, an oil-seed farmer may go short in oil-seed futures, thus ‘locking’ his sale price and
in the process hedging against any adverse price movements. On the other hand, a processor of
oil seeds may buy oil-seed futures and thus assure him a supply of oil-seeds at a predetermined
price. Similarly the oil-seed processor may go short in oil futures, which may be bought by a
wholesaler of oil.
Also, there is a saying that “gold shines when everything fails.” Thus, gold can be used as a
hedging tool against other investments.
Arbitrage: Traders may exploit arbitrage opportunities that arise on account of different prices
between the two exchanges or between different maturities in the same underlying.
List of exchanges and their respective traded commodities is given below:
1. Bhatinda Om & Oil Exchange Ltd., Bhatinda Gur
2. The Bombay Commodity Exchange Ltd., Mumbai RBD Palmolive, Groundnut Oil, Sunflower
Oil, Cottonseed, Safflower, Groundnut, Castor
oil-Int'l, Castor seed, Cottonseed oil, Seasum
oil, Seasum Oilcake, Safflower, Oilcake, Rice
Bran, Rice Bran Oil, Rice Bran Oilcake,
Safflower Oil, Crude Palm Oil
3. The Rajkot Seeds Oil & Bullion Merchants` Groundnut Oil, Castor seed
Association Ltd.
4. The Meerut Agro Commodities Exchange Co. Gur
Ltd., Meerut
5. The Spices and Oilseeds Exchange Ltd. Turmeric
Contd...

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