What is Commodity Futures?
A Commodity futures is an agreement between two parties to buy or sell a specified and standardized quantity of a commodity at a certain time in future at a price agreed upon at the time of entering into the contract on the commodity futures exchange.
The need for a futures market arises mainly due to the hedging function that it can perform. Commodity markets, like any other financial instrument, involve risk associated with frequent price volatility. The loss due to price volatility can be attributed to the following reasons:
Consumer Preferences: –
In the short-term, their influence on price volatility is small since it is a slow process permitting manufacturers, dealers and wholesalers to adjust their inventory in advance.
Changes in supply: –
They are abrupt and unpredictable bringing about wild fluctuations in prices. This can especially noticed in agricultural commodities where the weather plays a major role in affecting the fortunes of people involved in this industry. The futures market has evolved to neutralize such risks through a mechanism; namely hedging.
Benefits of Commodity Futures Markets:-
The primary objectives of any futures exchange are authentic price discovery and an efficient price risk management. The beneficiaries include those who trade in the commodities being offered in the exchange as well as those who have nothing to do with futures trading. It is because of price discovery and risk management through the existence of futures exchanges that a lot of businesses and services are able to function smoothly.
- Price Discovery
- Price Risk Management
- Import- Export competitiveness
- Predictable Pricing
- Benefits for farmers/Agriculturalists
- Credit accessibility
- Improved product quality
The history of organized commodity derivatives in India goes back to the nineteenth century when Cotton Trade Association started futures trading in 1875, about a decade after they started in Chicago. Over the time datives market developed in several commodities in India. Following Cotton, derivatives trading started in oilseed in Bombay (1900), raw jute and jute goods in Calcutta (1912), Wheat in Hapur (1913) and Bullion in Bombay (1920).
The commodities future market remained dismantled and remained dormant for about four decades until the new millennium when the Government, in a complete change in a policy, started actively encouraging commodity market. After Liberalization and Globalization in 1990, the Government set up a committee (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 Forward Markets Commission, and certain amendments to Forward Contracts (Regulation) Act 1952, particularly allowing option trading in goods and registration of brokers with Forward Markets Commission. The Government accepted most of these recommendations and futures’ trading was permitted in all recommended commodities. It is timely decision since internationally the commodity cycle is on upswing and the next decade being touched as the decade of Commodities.
Commodity exchange in India plays an important role where the prices of any commodity are not fixed, in an organized way. Earlier only the buyer of produce and its seller in the market judged upon the prices. Others never had a say.
In India there are 25 recognized future exchanges, of which there are three national level multi-commodity exchanges. After a gap of almost three decades, Government of India has allowed forward transactions in commodities through Online Commodity Exchanges, a modification of traditional business known as Adhat and Vayda Vyapar to facilitate better risk coverage and delivery of commodities. The three exchanges are: National Commodity & Derivatives Exchange Limited (NCDEX) Mumbai, Multi Commodity Exchange of India Limited (MCX) Mumbai and National Multi-Commodity Exchange of India Limited (NMCEIL) Ahmedabad.There are other regional commodity exchanges situated in different parts of India.