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Commodity Trading

A commodity is generally considered to be any kind of tangible good that can be interchanged with other goods of the same type. According to the Securities Contracts (Regulation) Act, 1956 (SCRA) "goods" mean every kind of movable property other than actionable claims, money and securities. Commodities are mostly used as inputs in the production of other goods or services. Grains, Gold, Crude Oil, Copper, Natural Gas are some examples of commodities.

The commodities traded in the Indian commodity derivative markets are usually classified into four segments. These are as follows:

  • Agricultural Commodities: These are generally perishable agricultural products such as soybean, cotton, chana, maize, sugar, guar seed etc. Processed agricultural commodities like soybean oil, palm oil, guar gum etc. are also considered as agricultural commodities.
  • Bullion and Gems: This segment predominantly consists of precious metals like gold, silver and precious gems like diamond.
  • Energy commodities: This segment includes commodities that serve as major energy sources. These commodities are traded in both the unprocessed form in which they are extracted or in various refined forms or by-products of refining / processing. Crude oil, natural gas etc. are examples of energy commodities.
  • Metal commodities: This segment includes various non-precious metals that are mined or processed from the mined metals such as copper, brass, iron, steel, etc.

The players in the commodity derivatives market can be classified into two major categories - risk givers and risk takers. Risk givers or hedgers refer to those who have a risk due to physical exposure to the commodity, and are looking to pass on their risk by taking a sell or buy position on Stock Exchange. Risk takers or investors refer to those who do not have physical exposure to the commodity, but who are willing to take a buy or sell position or risk with the aim of making gains from inequalities in the market. Financial investors and arbitrageurs are the investors in this market.

A call option conveys to the option buyer the right to purchase a particular futures contract at a stated price at any time during the life of the option.

A put option conveys to the option buyer the right to sell a particular futures contract at a stated price at any time during the life of the option.

The option buyer is the person who acquires the rights conveyed by the option seller.

The option seller (also known as the option writer or option grantor) is the party that conveys the option rights to the option buyer.

A forward contract is a customized contract between two parties, where settlement takes place on a specific date in future at a price agreed today. The main features of forward contracts are

  • They are bilateral contracts and hence exposed to counter-party risk.
  • Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality.
  • The contract price is generally not available in public domain.
  • The contract has to be settled by delivery of the asset on expiration date.
  • In case the party wishes to reverse the contract, it has to compulsorily go to the same counter party, which being in a monopoly situation can command the price it wants.
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