What is Commodities Future Trading?

As a customer, you can trade on commodity futures on MEX Nepal. It comes with a comprehensive tracking cum risk management solution to give you enhanced leveraging on your trading limits.

In futures trading, you take buy/sell positions in commodity contracts expiring in different months. If, during the course of the contract life, the price moves in your favor (rises in case you have a buy position or falls in case you have a sell position), you make a profit. In case the price movement is adverse, you incur a loss.

To take the buy/sell position on commodity futures, you have to place certain % of order value as margin. With futures trading, you can leverage on your trading limit by taking buy/sell positions much more than what you could have taken in the spot market. However, the risk profile of your transactions goes up.

What is an "Underlying"?

A commodity enabled for trading on futures is called an "Underlying" e.g. Pure Gold, Rubber. There may be various tradable contracts for the same underlying based on their different expiration period.

How much Quantity of a contract can I buy or Sell?
Positions can be taken in the contracts in the multiples of Lot size as specified by the exchange. For eg. The Trading lot of Gold is Grams(gms). Exchange has specified a client wise position limit for each underlying as mentioned in its contract specification.

How is the value of the trade calculated?

It is not necessary that the unit of quantity and price is the same. For eg. Price for Gold is expressed in Rs per 10 gms but the quantity is submitted in gms. Therefore the quantity can not be multiplied directly. The value of an order/trade can be computed by multiplying the quantity with the price and then the result by the 'multiplier'. For eg. Multiplier incase of Gold is 10.

Why does Exchange collect margin money?

The aim of margin money is to minimize the risk of default by either counter party. The amount of initial margin is so fixed as to ensure that the probability of loss on account of worst possible price fluctuation, which cannot be met by the amount of ordinary/initial margin, is very low. The Exchanges fix rates of ordinary/initial margin keeping in view need to balance high security of contract and low cost of entering into contract.

What are the different types of margins payable on futures?

Different margins payable on futures contracts are:
Ordinary/initial margin, maintenance margin, mark-to-market margin, special margin, volatility margin, and delivery margin.

What is initial/ordinary margin?

It is the amount to be deposited by the market participants in his margin account with clearing house before they can place order to buy or sell a futures contract. This must be maintained throughout the time their position is open and is returnable at delivery, exercise, expiry or closing out.

What is Mark-to-Market margin?

Mark-to-market margins (MTM or M2M) are payable based on closing prices at the end of each trading day. These margins will be paid by the buyer if the price declines and by the seller if the price rises. This margin is worked out on difference between the closing/clearing rate and the rate of the contract (if it is entered into on that day) or the previous day's clearing rate. The Exchange collects these margins from buyers if the prices decline and pays to the sellers and vice versa.

Why is Mark-to-Market margin collected daily in commodity market?

Collecting mark-to-market margin on a daily basis reduces the possibility of accumulation of loss, particularly when futures price moves only in one direction. Hence the risk of default is reduced. Also, the participants are required to pay less upfront margin - which is normally collected to cover the maximum, say, 99.9%, of the potential risk during the period of mark-to-market, for a given limit on open position. Alternatively, for the given upfront margin the limit on open position would have to be reduced, which has the effect of restraining the trade and liquidity.

How much margin would be blocked on placing the futures order?

Initially, margin is blocked at the applicable margin percentage of the order value. For market orders, margin is blocked considering the order price as the last traded price of the contract. On execution of the order, the same is suitably adjusted as per the actual execution price of the market order. If order is placed in the period after the delivery request window opens for the contract, the order may also attract delivery margin (explained later).

Is the margin % uniform for all commodities?

It may not be so. Margin percentage may differ from commodity to commodity based on the risk involved in it, which depends upon its liquidity and volatility besides the general market conditions. But all contracts within the same underlying would attract same margin %.

What is meant by Minimum Margin?

Minimum Margin is the margin amount which you should have available with us all the time. Once the available margin with us goes below the required minimum margin, our system would block additional margin required from the limit available.

What is a Derivative contract?

Each commodity is different. There are even different delivery months of the same commodity. Understanding the futures contract specifications is at the heart of knowing the rules that govern trading a commodity futures contract, as well as the price movement value of each commodity. The Futures contract specifications which are printed in Commodity specifications. Trading on futures contract based on specification of quality, quantity, and price, trading procedures, delivery procedures and settlement mechanism. This comes all together as contract specification.

What is a forward contract?

A forward contract is a legally enforceable agreement for delivery of goods or the underlying asset on a specific date in future at a price agreed on the date of contract. All the contracts for delivery of goods, which are settled by payment of money difference or where delivery and payment is made after a period of specific days, are forward contracts.

What are standardized contracts?

Futures contracts are standardized. In other words, the parties to the contracts do not decide the terms of futures contracts; but they merely accept terms of contracts standardized by the Exchange

What are the benefits from Commodity Forward/Futures Trading?

Forward/Futures trading performs two important functions, namely, price discovery and price risk management with reference to the given commodity. It is useful to all segments of the economy. It enables the ‘Consumer' in getting an idea of the price at which the commodity would be available at a future point of time. He can do proper costing and also cover his purchases by making forward contracts.

It is very useful to the ‘exporter' as it provides an advance indication of the price likely to prevail and thereby helps him in quoting a realistic price and secure export contract in a competitive market. It ensures balance in supply and demand position throughout the year and leads to integrated price structure throughout the country. It also helps in removing risk of price uncertainty, encourages competition and acts as a price barometer to farmers and other functionaries in the economy.

What is hedging?

Hedging is a mechanism by which the participants in the physical/cash markets can cover their price risk. Theoretically, the relationship between the futures and cash prices is determined by cost of carry. The two prices therefore move in tandem. This enables the participants in the physical/cash markets to cover their price risk by taking opposite position in the futures market.

Illustrate hedging by a stockiest by using futures market?

To illustrate the concept of hedging, let us assume that, on 1st December, 2008, a stockiest purchases, say, 10 tonnes of paddy in the physical market @ Rs. 1600/- p.q.. To hedge price-risk, he would simultaneously sell 10 contracts of one tonne each in the futures market at the prevailing price. Assuming the ruling price in May, 2009 contract is Rs.1750/- p.q., the stockiest is able to lock in a spread of Rs. 150/- p.q., i.e., about 9% for about 6 months.

The stockiest would, in the first instance, take the decision to purchase stock only if such a spread covers his cost of carry and a reasonable profit of margin. Assuming that the stockiest sells his stock in the month of April when the spot price is Rs. 1500/- p.q. The stockiest would incur a loss of Rs. 100/- p.q. on his physical stocks. He would also make a loss of expenses incurred for carrying the stocks. However, since the spot and futures prices move in parity, futures price is also likely to decline, say, from Rs. 1750/- p.q. to, say, Rs. 1625/- p.a.

The stockiest can liquidate his contract in the futures market by entering into purchase contract @ Rs. 1625/- p.q. He would end up earning a profit of Rs. 125/- in the futures segment. Looking at the gain/loss in the two segments, we find that the stockiest is able to hedge his price risk by operating simultaneously in the two markets and taking opposite positions. He gains in the futures market if he loses in the spot market; but he would lose in futures market if he gains in the spot market. Similarly, processors, exporters, and importers can also hedge their price risks.

How does futures market benefit farmers?

World over, farmers do not directly participate in the futures market. They take advantage of the price signals emanating from a futures market. Price-signals given by long-duration new-season futures contract can help farmers to take decision about cropping pattern and the investment intensity of cultivation. Direct participation of farmers in futures market to manage price risk -either as associates of an Exchange or as clients of some associates- can be cumbersome as it involves meeting various associates criteria and payment of daily margins etc. Options in goods would be relatively more farmer-friendly.

Who can be members of the Exchange?

The Bye-laws and Articles of the Association prescribed the criteria for being associates of the Exchange. Any person desirous of being an associate of the Exchange may approach the contact persons whose names, telephone numbers, fax numbers, email addresses etc. are available on the website of MEX: . They may also refer to the Bye-law and Articles of Association of the concerned Exchange which contain various criteria for the associates of the Exchange.

Who are the participants in forward/futures markets?

Participants in forward/futures markets are hedgers, speculators, day-traders/scalpers, market makers, and, arbitrageurs.

Who is hedger?

Hedger is a user of the market, who enters into futures contract to manage the risk of adverse price fluctuation in respect of his existing or future asset.

What is arbitrage?

Arbitrage refers to the simultaneous purchase and sale in two markets so that the selling price is higher than the buying price by more than the transaction cost, so that the arbitrageur makes risk-less profit.

Who are day-traders?

Day traders are speculators who take positions in spot, futures or options contracts and liquidate them prior to the close of the same trading day.

Who is floor-trader?

A floor trader is an Exchange's associates or its employee, who executes trade by being personally present in the trading ring or pit, floor trader has also place in electronic trading systems.

Who is speculator?

Ans. A trader, who trades or takes position without having exposure in the physical market, with the sole intention of earning profit is a speculator.

Who is market maker?

Ans. A market maker is a trader, who simultaneously quotes both bid and offer price for a same commodity throughout the trading session.

What are the legal and regulatory provisions for customer protection?

As trading based on contractual form of agreement, so all the investors are protected legally about their trade as contract. Apart from that exchange it is regulating the behavior of its members, so customers are fully protected through legal way and from exchange's side as well.

What is bucketing?

Member is said to be indulging in bucketing, when he takes directly or indirectly, the opposite side of a customer's order either on his own account or into on account in which he or she has an interest, without executing the order on an Exchange. Appropriation of clients' trade without written consent constitutes unauthorized activities of Members.

What is Options in Commodities?

Options in goods is an agreement by whatever name called, like, Teji-Mandi, under which buyer of the option (called as applier) pays a premium to the seller of option (called as writer of the option) for acquiring from him right to buy or sell the goods at a mutually agreed rate (called as strike price), in respect of which the premium amount is paid.

When the buyer acquires right to buy, it is called as a "call" (Teji) and when he acquires right to sell it is called a "put" (Mandi) option. It is possible to acquire rights both to buy and to sell the goods; but in this case higher premium amount would have to be paid. The buyer acquires only right, i.e., he is under no obligation to buy or sell, as the case may be, at the mutually agreed price.