Commodity Studymaterial

Contents

1 Introduction to derivatives 91.1 Derivatives defined . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91.2 Products, participants and functions . . . . . . . . . . . . . . . . . . . . . . . . 101.3 Derivatives markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

1.3.1 Spot versus forward transaction . . . . . . . . . . . . . . . . . . . . . . 121.3.2 Exchange traded versus OTC derivatives . . . . . . . . . . . . . . . . . . 121.3.3 Some commonly used derivatives . . . . . . . . . . . . . . . . . . . . . 14

2 Commodity derivatives 172.1 Difference between commodity and financial derivatives . . . . . . . . . . . . . 17

2.1.1 Physical settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172.1.2 Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192.1.3 Quality of underlying assets . . . . . . . . . . . . . . . . . . . . . . . . 20

2.2 Global commodities derivatives exchanges . . . . . . . . . . . . . . . . . . . . . 202.2.1 Africa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222.2.2 Asia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222.2.3 Latin America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

2.3 Evolution of the commodity market in India . . . . . . . . . . . . . . . . . . . . 222.3.1 The Kabra committee report . . . . . . . . . . . . . . . . . . . . . . . . 232.3.2 Latest developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

3 The NCDEX platform 293.1 Structure of NCDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

3.1.1 Promoters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303.1.2 Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

3.2 Exchange membership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303.2.1 Trading cum clearing members (TCMs) . . . . . . . . . . . . . . . . . . 303.2.2 Professional clearing members (PCMs) . . . . . . . . . . . . . . . . . . 31

3.3 Capital requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 313.4 The NCDEX system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

3.4.1 Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 323.4.2 Clearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 333.4.3 Settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

4 CONTENTS

4 Commodities traded on the NCDEX platform 354.1 Agricultural commodities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

4.1.1 Cotton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 364.1.2 Crude palm oil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 384.1.3 RBD Palmolein . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 404.1.4 Soy oil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 414.1.5 Rapeseed oil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 434.1.6 Soybean . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 444.1.7 Rapeseed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

4.2 Precious metals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 474.2.1 Gold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 484.2.2 Silver . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

5 Instruments available for trading 575.1 Forward contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

5.1.1 Limitations of forward markets . . . . . . . . . . . . . . . . . . . . . . 585.2 Introduction to futures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

5.2.1 Distinction between futures and forwards contracts . . . . . . . . . . . . 595.2.2 Futures terminology . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

5.3 Introduction to options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 605.3.1 Option terminology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

5.4 Basic payoffs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 625.4.1 Payoff for buyer of asset: Long asset . . . . . . . . . . . . . . . . . . . . 635.4.2 Payoff for seller of asset: Short asset . . . . . . . . . . . . . . . . . . . . 63

5.5 Payoff for futures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 635.5.1 Payoff for buyer of futures: Long futures . . . . . . . . . . . . . . . . . 635.5.2 Payoff for seller of futures: Short futures . . . . . . . . . . . . . . . . . 65

5.6 Payoff for options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 665.6.1 Payoff for buyer of call options: Long call . . . . . . . . . . . . . . . . . 665.6.2 Payoff for writer of call options: Short call . . . . . . . . . . . . . . . . 675.6.3 Payoff for buyer of put options: Long put . . . . . . . . . . . . . . . . . 675.6.4 Payoff for writer of put options: Short put . . . . . . . . . . . . . . . . . 68

5.7 Using futures versus using options . . . . . . . . . . . . . . . . . . . . . . . . . 69

6 Pricing commodity futures 756.1 Investment assets versus consumption assets . . . . . . . . . . . . . . . . . . . . 756.2 The cost of carry model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76

6.2.1 Pricing futures contracts on investment commodities . . . . . . . . . . . 786.2.2 Pricing futures contracts on consumption commodities . . . . . . . . . . 80

6.3 The futures basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

CONTENTS 5

7 Using commodity futures 857.1 Hedging . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

7.1.1 Basic principles of hedging . . . . . . . . . . . . . . . . . . . . . . . . . 857.1.2 Short hedge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 867.1.3 Long hedge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 877.1.4 Hedge ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 897.1.5 Advantages of hedging . . . . . . . . . . . . . . . . . . . . . . . . . . . 907.1.6 Limitation of hedging: basis Risk . . . . . . . . . . . . . . . . . . . . . 91

7.2 Speculation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 927.2.1 Speculation: Bullish commodity, buy futures . . . . . . . . . . . . . . . 927.2.2 Speculation: Bearish commodity, sell futures . . . . . . . . . . . . . . . 93

7.3 Arbitrage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 937.3.1 Overpriced commodity futures: buy spot, sell futures . . . . . . . . . . . 947.3.2 Underpriced commodity futures: buy futures, sell spot . . . . . . . . . . 95

8 Trading 998.1 Futures trading system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 998.2 Entities in the trading system . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99

8.2.1 Guidelines for allotment of client code . . . . . . . . . . . . . . . . . . . 1008.3 Contract specifications for commodity futures . . . . . . . . . . . . . . . . . . . 1018.4 Commodity futures trading cycle . . . . . . . . . . . . . . . . . . . . . . . . . . 1018.5 Order types and trading parameters . . . . . . . . . . . . . . . . . . . . . . . . . 102

8.5.1 Permitted lot size . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1068.5.2 Tick size for contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . 1068.5.3 Quantity freeze . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1078.5.4 Base price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1078.5.5 Price ranges of contracts . . . . . . . . . . . . . . . . . . . . . . . . . . 1078.5.6 Order entry on the trading system . . . . . . . . . . . . . . . . . . . . . 108

8.6 Margins for trading in futures . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1108.7 Charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

9 Clearing and settlement 1159.1 Clearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115

9.1.1 Clearing mechanism . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1169.1.2 Clearing banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1169.1.3 Depository participants . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

9.2 Settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1179.2.1 Settlement mechanism . . . . . . . . . . . . . . . . . . . . . . . . . . . 1179.2.2 Settlement methods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1209.2.3 Entities involved in physical settlement . . . . . . . . . . . . . . . . . . 122

9.3 Risk management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1239.4 Margining at NCDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124

9.4.1 SPAN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124

6 CONTENTS

9.4.2 Initial margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1249.4.3 Computation of initial margin . . . . . . . . . . . . . . . . . . . . . . . 1249.4.4 Implementation aspects of margining and risk management . . . . . . . . 1269.4.5 Effect of violation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

10 Regulatory framework 13310.1 Rules governing commodity derivatives exchanges . . . . . . . . . . . . . . . . 13310.2 Rules governing intermediaries . . . . . . . . . . . . . . . . . . . . . . . . . . . 134

10.2.1 Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13410.2.2 Clearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138

10.3 Rules governing investor grievances, arbitration . . . . . . . . . . . . . . . . . . 14210.3.1 Procedure for arbitration . . . . . . . . . . . . . . . . . . . . . . . . . . 14310.3.2 Hearings and arbitral award . . . . . . . . . . . . . . . . . . . . . . . . 144

11 Implications of sales tax 147

List of Tables

2.1 The global derivatives industry . . . . . . . . . . . . . . . . . . . . . . . . . . . 212.2 Volume on existing exchanges . . . . . . . . . . . . . . . . . . . . . . . . . . . 252.3 Registered commodity exchanges in India . . . . . . . . . . . . . . . . . . . . . 26

3.1 Fee/ deposit structure and networth requirement: TCM . . . . . . . . . . . . . . 313.2 Fee/ deposit structure and networth requirement: PCM . . . . . . . . . . . . . . 31

4.1 Countrywise share in gold production, 1968 and 1999 . . . . . . . . . . . . . . 49

5.1 Distinction between futures and forwards . . . . . . . . . . . . . . . . . . . . . 595.2 Distinction between futures and options . . . . . . . . . . . . . . . . . . . . . . 70

6.1 NCDEX indicative warehouse charges . . . . . . . . . . . . . . . . . . . . . . 80

7.1 Refined soy oil futures contract specification . . . . . . . . . . . . . . . . . . . . 877.2 Silver futures contract specification . . . . . . . . . . . . . . . . . . . . . . . . . 887.3 Gold futures contract specification . . . . . . . . . . . . . . . . . . . . . . . . . 92

8.1 Commodity futures contract and their symbols . . . . . . . . . . . . . . . . . . . 1018.2 Gold futures contract specification . . . . . . . . . . . . . . . . . . . . . . . . . 1028.3 Long staple cotton futures contract specification . . . . . . . . . . . . . . . . . . 1038.4 Commodity futures: Quantity freeze unit . . . . . . . . . . . . . . . . . . . . . . 1078.5 Commodity futures: Lot size and other parameters . . . . . . . . . . . . . . . . 109

9.1 MTM on a long position in cotton futures . . . . . . . . . . . . . . . . . . . . . 1189.2 MTM on a short position in cotton futures . . . . . . . . . . . . . . . . . . . . . 1199.3 Calculating outstanding position at TCM level . . . . . . . . . . . . . . . . . . . 1259.4 Minimum margin percentage on commodity futures contracts . . . . . . . . . . . 1259.5 Exposure limit as a multiple of liquid net worth . . . . . . . . . . . . . . . . . . 1289.6 Number of days for physical settlement on various commodities . . . . . . . . . 129

List of Figures

5.1 Payoff for a buyer of gold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 645.2 Payoff for a seller of gold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 645.3 Payoff for a buyer of gold futures . . . . . . . . . . . . . . . . . . . . . . . . . . 655.4 Payoff for a seller of cotton futures . . . . . . . . . . . . . . . . . . . . . . . . . 665.5 Payoff for buyer of call option on gold . . . . . . . . . . . . . . . . . . . . . . . 675.6 Payoff for writer of call option on gold . . . . . . . . . . . . . . . . . . . . . . . 685.7 Payoff for buyer of put option on long staple cotton . . . . . . . . . . . . . . . . 695.8 Payoff for writer of put option on long staple cotton . . . . . . . . . . . . . . . . 70

6.1 Variation of basis over time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82

7.1 Payoff for buyer of a short hedge . . . . . . . . . . . . . . . . . . . . . . . . . . 867.2 Payoff for buyer of a long hedge . . . . . . . . . . . . . . . . . . . . . . . . . . 88

8.1 Contract cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104

Chapter 1

Introduction to derivatives

The origin of derivatives can be traced back to the need of farmers to protect themselves againstfluctuations in the price of their crop. From the the time it was sown to the time it was readyfor 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 lockingin asset prices.These were simple contracts developed to meet the needs of farmers and were basically a meansof reducing risk.

A farmer who sowed his crop in June faced uncertainty over the price he would receive for hisharvest in September. In years of scarcity, he would probably obtain attractive prices. However,during times of oversupply, he would have to dispose off his harvest at a very low price. Clearlythis meant 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 pricerisk that of having to pay exorbitant prices during dearth, although favourable prices could beobtained during periods of oversupply. Under such circumstances, it clearly made sense for thefarmer and the merchant to come together and enter into a contract whereby the price of the grainto be delivered in September could be decided earlier. What they would then negotiate happenedto be a futurestype contract, which would enable both parties to eliminate the price risk.

In 1848, the Chicago Board of Trade, or CBOT, was established to bring farmers andmerchants together. A group of traders got together and created the toarrive contract thatpermitted farmers to lock in to price upfront and deliver the grain later. These to-arrive contractsproved useful as a device for hedging and speculation on price changes. These were eventuallystandardised, and in 1925 the first futures clearing house came into existence.

Today, derivative contracts exist on a variety of commodities such as corn, pepper, cotton,wheat, silver, etc. Besides commodities, derivatives contracts also exist on a lot of financialunderlyings like stocks, interest rate, exchange rate, etc.

1.1 Derivatives dened

A derivative is a product whose value is derived from the value of one or more underlyingvariables or assets in a contractual manner. The underlying asset can be equity, forex, commodity

12 Introduction to derivatives

or any other asset. In our earlier discussion, we saw that wheat farmers may wish to sell theirharvest at a future date to eliminate the risk of a change in prices by that date. Such a transactionis an example of a derivative. The price of this derivative is driven by the spot price of wheatwhich is the underlying in this case.

The Forwards Contracts (Regulation) Act, 1952, regulates the forward/ futures contracts incommodities all over India. As per this the Forward Markets Commission (FMC) continues tohave jurisdiction over commodity forward/ futures contracts. However when derivatives tradingin securities was introduced in 2001, the term security in the Securities Contracts (Regulation)Act, 1956 (SCRA), was amended to include derivative contracts in securities. Consequently,regulation of derivatives came under the perview of Securities Exchange Board of India (SEBI).We thus have separate regulatory authorities for securities and commodity derivative markets.

Derivatives are securities under the SCRA and hence the trading of derivatives is governedby the regulatory framework under the SCRA. The Securities Contracts (Regulation) Act, 1956(SC(R)A) defines derivative to include

1. A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrumentor contract for differences or any other form of security.

2. A contract which derives its value from the prices, or index of prices, of underlying securities.

1.2 Products, participants and functionsDerivative contracts are of different types. The most common ones are forwards, futures, optionsand swaps. Participants who trade in the derivatives market can be classified under the followingthree broad categories hedgers, speculators, and arbitragers.

1. Hedgers: The farmers example that we discussed about was a case of hedging. Hedgers face riskassociated with the price of an asset. They use the futures or options markets to reduce or eliminatethis risk.

2. Speculators: Speculators are participants who wish to bet on future movements in the price of anasset. Futures and options contracts can give them leverage; that is, by putting in small amounts ofmoney upfront, they can take large positions on the market. As a result of this leveraged speculativeposition, they increase the potential for large gains as well as large losses.

3. Arbitragers: Arbitragers work at making profits by taking advantage of discrepancy between pricesof the same product across different markets. If, for example, they see the futures price of an assetgetting out of line with the cash price, they would take offsetting positions in the two markets to lockin the profit.

Whether the underlying asset is a commodity or a financial asset, derivative markets performsa number of economic functions. Prices in an organised derivatives market reflect the perception of market participants about the future

and lead the prices of underlying to the perceived future level. The prices of derivatives convergewith the prices of the underlying at the expiration of the derivative contract. Thus derivatives help indiscovery of future as well as current prices.

1.3 Derivatives markets 13

Derivative products initially emerged as hedging devices against fluctuations in commodity prices,and commodity-linked derivatives remained the sole form of such products for almost three hundredyears. Financial derivatives came into spotlight in the post-1970 period due to growing instability inthe financial markets. However, since their emergence, these products have become very popular andby 1990s, they accounted for about two-thirds of total transactions in derivative products. In recentyears, the market for financial derivatives has grown tremendously in terms of variety of instrumentsavailable, their complexity and also turnover. In the class of equity derivatives the world over, futuresand options on stock indices have gained more popularity than on individual stocks, especially amonginstitutional investors, who are major users of index-linked derivatives. Even small investors find theseuseful due to high correlation of the popular indexes with various portfolios and ease of use. The lowercosts associated with index derivatives visavis derivative products based on individual securities isanother reason for their growing use.

Box 1.1: Emergence of financial derivative products

The derivatives market helps to transfer risks from those who have them but may not like them tothose who have an appetite for them.

Derivatives, due to their inherent nature, are linked to the underlying cash markets. With theintroduction of derivatives, the underlying market witnesses higher trading volumes because ofparticipation by more players who would not otherwise participate for lack of an arrangement totransfer risk.

Speculative traders shift to a more controlled environment of the derivatives market. In the absenceof an organised derivatives market, speculators trade in the underlying cash markets. Margining,monitoring and surveillance of the activities of various participants become extremely difficult inthese kind of mixed markets.

An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for newentrepreneurial activity. Derivatives have a history of attracting many bright, creative, welleducatedpeople with an entrepreneurial attitude. They often energize others to create new businesses, newproducts and new employment opportunities, the benefit of which are immense.

Derivatives markets help increase savings and investment in the long run. The transfer of risk enablesmarket participants to expand their volume of activity.

1.3 Derivatives markets

Derivative markets can broadly be classified as commodity derivative market and financialderivatives markets. As the name suggest, commodity derivatives markets trade contracts forwhich the underlying asset is a commodity. It can be an agricultural commodity like wheat,soybeans, rapeseed, cotton, etc or precious metals like gold, silver, etc. Financial derivativesmarkets trade contracts that have a financial asset or variable as the underlying. The morepopular financial derivatives are those which have equity, interest rates and exchange rates as


the underlying. The most commonly used derivatives contracts are forwards, futures and optionswhich we shall discuss in detail later.

1.3.1 Spot versus forward transactionUsing the example of a forward contract, let us try to understand the difference between aspot and derivatives contract. Every transaction has three components trading, clearing andsettlement. A buyer and seller come together, negotiate and arrive at a price. This is trading.Clearing involves finding out the net outstanding, that is exactly how much of goods and moneythe two should exchange. For instance A buys goods worth Rs.100 from B and sells goods worthRs.50 to B. On a net basis A has to pay Rs.50 to B. Settlement is the actual process of exchangingmoney and goods.

In a spot transaction, the trading, clearing and settlement happens instantaneously, i.e. onthe spot. Consider this example. On 1st January 2004, Aditya wants to buy some gold. Thegoldsmith quotes Rs.6,000 per 10 grams. They agree upon this price and Aditya buys 20 gramsof gold. He pays Rs.12,000, takes the gold and leaves. This is a spot transaction.

Now suppose Aditya does not want to buy the gold on the 1st January, but wants to buy ita month later. The goldsmith quotes Rs.6,015 per 10 grams. They agree upon the forwardprice for 20 grams of gold that Aditya wants to buy and Aditya leaves. A month later, he paysthe goldsmith Rs.12,030 and collects his gold. This is a forward contract, a contract by whichtwo parties irrevocably agree to settle a trade at a future date, for a stated price and quantity. Nomoney changes hands when the contract is signed. The exchange of money and the underlyinggoods only happens at the future date as specified in the contract. In a forward contract theprocess of trading, clearing and settlement does not happen instantaneously. The trading happenstoday, but the clearing and settlement happens at the end of the specified period.

A forward is the most basic derivative contract. We call it a derivative because it derivesvalue from the price of the asset underlying the contract, in this case gold. If on the 1st ofFebruary, gold trades for Rs.6,050 in the spot market, the contract becomes more valuable toAditya because it now enables him to buy gold at Rs.6,015. If however, the price of gold dropsdown to Rs.5,990, he is worse off because as per the terms of the contract, he is bound to payRs.6,015 for the same gold. The contract has now lost value from Adityas point of view. Notethat the value of the forward contract to the goldsmith varies exactly in an opposite manner to itsvalue for Aditya.

1.3.2 Exchange traded versus OTC derivativesDerivatives have probably been around for as long as people have been trading with one another.Forward contracting dates back at least to the 12th century, and may well have been around beforethen. These contracts were typically OTC kind of contracts. Over the counter(OTC) derivativesare privately negotiated contracts. Merchants entered into contracts with one another for futuredelivery of specified amount of commodities at specified price. A primary motivation for prearranging a buyer or seller for a stock of commodities in early forward contracts was to lessenthe possibility that large swings would inhibit marketing the commodity after a harvest. Later


Early forward contracts in the US addressed merchants concerns about ensuring that there were buyersand sellers for commodities. However credit risk remained a serious problem. To deal with thisproblem, a group of Chicago businessmen formed the Chicago Board of Trade (CBOT) in 1848. Theprimary intention of the CBOT was to provide a centralised location known in advance for buyers andsellers to negotiate forward contracts. In 1865, the CBOT went one step further and listed the firstexchange traded derivatives contract in the US, these contracts were called futures contracts. In1919, Chicago Butter and Egg Board, a spin-off of CBOT, was reorganised to allow futures trading.Its name was changed to Chicago Mercantile Exchange (CME). The CBOT and the CME remain thetwo largest organised futures exchanges, indeed the two largest financial exchanges of any kind inthe world today.The first stock index futures contract was traded at Kansas City Board of Trade. Currently themost popular stock index futures contract in the world is based on S&P 500 index, traded on ChicagoMercantile Exchange. During the mid eighties, financial futures became the most active derivativeinstruments generating volumes many times more than the commodity futures. Index futures, futureson T-bills and Euro-Dollar futures are the three most popular futures contracts traded today. Otherpopular international exchanges that trade derivatives are LIFFE in England, DTB in Germany, SGXin Singapore, TIFFE in Japan, MATIF in France, Eurex etc.

Box 1.2: History of commodity derivatives markets

many of these contracts were standardised in terms of quantity and delivery dates and began totrade on an exchange.

The OTC derivatives markets have the following features compared to exchange-tradedderivatives:

1. The management of counter-party (credit) risk is decentralised and located within individualinstitutions.

2. There are no formal centralised limits on individual positions, leverage, or margining.

3. There are no formal rules for risk and burdensharing.

4. There are no formal rules or mechanisms for ensuring market stability and integrity, and forsafeguarding the collective interests of market participants.

5. The OTC contracts are generally not regulated by a regulatory authority and the exchanges selfregulatory organisation, although they are affected indirectly by national legal systems, bankingsupervision and market surveillance.

The OTC derivatives markets have witnessed rather sharp growth over the last fewyears, which has accompanied the modernisation of commercial and investment banking andglobalisation of financial activities. The recent developments in information technology havecontributed to a great extent to these developments. While both exchange-traded and OTCderivative contracts offer many benefits, the former have rigid structures compared to the latter.

The largest OTC derivative market is the interbank foreign exchange market. Commodityderivatives the world over are typically exchangetraded and not OTC in nature.


1.3.3 Some commonly used derivativesHere we define some of the more popularly used derivative contracts. Some of these, namelyfutures and options will be discussed in more details at a later stage.

Forwards: As we discussed, a forward contract is an agreement between two entities to buy or sell theunderlying asset at a future date, at todays pre-agreed price.

Futures: A futures contract is an agreement between two parties to buy or sell the underlying asset at afuture date at todays future price. Futures contracts differ from forward contracts in the sense thatthey are standardised and exchange traded.

Options: There are two types of options - calls and puts. Calls give the buyer the right but not theobligation to buy a given quantity of the underlying asset, at a given price on or before a given futuredate. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlyingasset at a given price on or before a given date.

Warrants: Options generally have lives of upto one year, the majority of options traded on optionsexchanges having a maximum maturity of nine months. Longerdated options are called warrantsand are generally traded overthecounter.

Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually aweighted average of a basket of assets. Equity index options are a form of basket options.

Swaps: Swaps are private agreements between two parties to exchange cash flows in the future accordingto a prearranged formula. They can be regarded as portfolios of forward contracts. The twocommonly used swaps are :

Interest rate swaps: These entail swapping only the interest related cash flows between theparties in the same currency. Currency swaps: These entail swapping both principal and interest between the parties,

with the cashflows in one direction being in a different currency than those in the oppositedirection.

Swaptions: Swaptions are options to buy or sell a swap that will become operative at the expiry of theoptions. Thus a swaption is an option on a forward swap.

Solved ProblemsQ: Futures trading commenced first on

1. Chicago Board of Trade

2. Chicago Mercantile Exchange

3. Chicago Board Options Exchange

4. London International Financial Futures andOptions Exchange

A: The correct answer is number 1.


Q: Derivatives first emerged as products

1. Speculative

2. Hedging

3. Volatility

4. Risky


Q: Which of the following exchanges offer commodity derivatives trading

1. National Commodity Derivatives Exchange

2. Interconnected Stock Exchange

3. Over The Counter Exchange of India

4. ICICI Securities Limited


Q: OTC derivatives are considered risky because

1. There is no formal margining system.

2. They do not follow any formal rules or mech-anisms.

3. They are not settled on a clearing house.

4. All of the above


Q: The first exchange traded financial derivative in India commenced with the trading of

1. Index futures

2. Index options

3. Stock options

4. Interest rate futures


Q: A is the simplest derivative contract

1. Option

2. Future

3. Forward

4. Swap


Q: In a transaction, trading involves

1. The buyer and seller agreeing upon a price.

2. The buyer and seller exchanging goods andmoney.

3. The buyer and seller calculating the net out-standing.

4. None of the above.



Q: In a transaction, clearing involves






Q: In a transaction, settlement involves






Chapter 2

Commodity derivatives

Derivatives as a tool for managing risk first originated in the commodities markets. They werethen found useful as a hedging tool in financial markets as well. In India, trading in commodityfutures has been in existence from the nineteenth century with organised trading in cotton throughthe establishment of Cotton Trade Association in 1875. Over a period of time, other commoditieswere permitted to be traded in futures exchanges. Regulatory constraints in 1960s resultedin virtual dismantling of the commodities future markets. It is only in the last decade thatcommodity future exchanges have been actively encouraged. However, the markets have beenthin with poor liquidity and have not grown to any significant level. In this chapter we look athow commodity derivatives differ from financial derivatives. We also have a brief look at theglobal commodity markets and the commodity markets that exist in India.

2.1 Difference between commodity and nancial derivatives

The basic concept of a derivative contract remains the same whether the underlying happens tobe a commodity or a financial asset. However there are some features which are very peculiarto commodity derivative markets. In the case of financial derivatives, most of these contractsare cash settled. Even in the case of physical settlement, financial assets are not bulky and donot need special facility for storage. Due to the bulky nature of the underlying assets, physicalsettlement in commodity derivatives creates the need for warehousing. Similarly, the conceptof varying quality of asset does not really exist as far as financial underlyings are concerned.However in the case of commodities, the quality of the asset underlying a contract can varylargely. This becomes an important issue to be managed. We have a brief look at these issues.

2.1.1 Physical settlementPhysical settlement involves the physical delivery of the underlying commodity, typically at anaccredited warehouse. The seller intending to make delivery would have to take the commoditiesto the designated warehouse and the buyer intending to take delivery would have to go to thedesignated warehouse and pick up the commodity. This may sound simple, but the physical

20 Commodity derivatives

settlement of commodities is a complex process. The issues faced in physical settlement areenormous. There are limits on storage facilities in different states. There are restrictions oninterstate movement of commodities. Besides state level octroi and duties have an impact onthe cost of movement of goods across locations. The process of taking physical delivery incommodities is quite different from the process of taking physical delivery in financial assets.We take a general overview at the process flow of physical settlement of commodities. Later onwe will look into details of how physical settlement happens on the NCDEX.

Delivery notice period

Unlike in the case of equity futures, typically a seller of commodity futures has the option togive notice of delivery. This option is given during a period identified as delivery notice period.Such contracts are then assigned to a buyer, in a manner similar to the assignments to a sellerin an options market. However what is interesting and different from a typical options exerciseis that in the commodities market, both positions can still be closed out before expiry of thecontract. The intention of this notice is to allow verification of delivery and to give adequatenotice to the buyer of a possible requirement to take delivery. These are required by virtue of thefact that the actual physical settlement of commodities requires preparation from both deliveringand receiving members.

Typically, in all commodity exchanges, delivery notice is required to be supported bya warehouse receipt. The warehouse receipt is the proof for the quantity and quality ofcommodities being delivered. Some exchanges have certified laboratories for verifying thequality of goods. In these exchanges the seller has to produce a verification report from theselaboratories along with delivery notice. Some exchanges like LIFFE, accept warehouse receiptsas quality verification documents while others like BMFBrazil have independent grading andclassification agency to verify the quality.

In the case of BMF-Brazil a seller typically has to submit the following documents:

A declaration verifying that the asset is free of any and all charges, including fiscal debts related tothe stored goods.

A provisional delivery order of the good to BM&F (Brazil), issued by the warehouse.

A warehouse certificate showing that storage and regular insurance have been paid.

Assignment

Whenever delivery notices are given by the seller, the clearing house of the exchange identifiesthe buyer to whom this notice may be assigned. Exchanges follow different practices for theassignment process. One approach is to display the delivery notice and allow buyers wishingto take delivery to bid for taking delivery. Among the international exchanges, BMF, CBOTand CME display delivery notices. Alternatively, the clearing houses may assign deliveries tobuyers on some basis. Exchanges such as COMMEX and the Indian commodities exchangeshave adopted this method.

2.1 Difference between commodity and nancial derivatives 21

Any seller/ buyer who has given intention to deliver/ been assigned a delivery has an option tosquare off positions till the market close of the day of delivery notice. After the close of trading,exchanges assign the delivery intentions to open long positions. Assignment is done typicallyeither on random basis or firstinfirst out basis. In some exchanges (CME), the buyer has theoption to give his preference for delivery location.

The clearing house decides on the daily delivery order rate at which delivery will be settled.Delivery rate depends on the spot rate of the underlying adjusted for discount/ premium forquality and freight costs. The discount/ premium for quality and freight costs are published bythe clearing house before introduction of the contract. The most active spot market is normallytaken as the benchmark for deciding spot prices. Alternatively, the delivery rate is determinedbased on the previous day closing rate for the contract or the closing rate for the day.

Delivery

After the assignment process, clearing house/ exchange issues a delivery order to the buyer. Theexchange also informs the respective warehouse about the identity of the buyer. The buyer isrequired to deposit a certain percentage of the contract amount with the clearing house as marginagainst the warehouse receipt.

The period available for the buyer to take physical delivery is stipulated by the exchange.Buyer or his authorised representative in the presence of seller or his representative takes thephysical stocks against the delivery order. Proof of physical delivery having been effected isforwarded by the seller to the clearing house and the invoice amount is credited to the sellersaccount.

In India if a seller does not give notice of delivery then at the expiry of the contract thepositions are cash settled by price difference exactly as in cash settled equity futures contracts.

2.1.2 WarehousingOne of the main differences between financial and commodity derivatives is the need forwarehousing. In case of most exchangetraded financial derivatives, all the positions are cashsettled. Cash settlement involves paying up the difference in prices between the time the contractwas entered into and the time the contract was closed. For instance, if a trader buys futureson a stock at Rs.100 and on the day of expiration, the futures on that stock close Rs.120, hedoes not really have to buy the underlying stock. All he does is take the difference of Rs.20 incash. Similarly the person who sold this futures contract at Rs.100, does not have to deliver theunderlying stock. All he has to do is pay up the loss of Rs.20 in cash.

In case of commodity derivatives however, there is a possibility of physical settlement. Whichmeans that if the seller chooses to hand over the commodity instead of the difference in cash, thebuyer must take physical delivery of the underlying asset. This requires the exchange to makean arrangement with warehouses to handle the settlements. The efficacy of the commoditiessettlements depends on the warehousing system available. Most international commodityexchanges used certified warehouses (CWH) for the purpose of handling physical settlements.Such CWH are required to provide storage facilities for participants in the commodities markets


The New York Cotton Exchange has specified the asset in its orange juice futures contract as U.SGrade A, with Brix value of not less than 57 degrees, having a Brix value to acid ratio of not less than13 to 1 nor more than 19 to 1, with factors of color and flavour each scoring 37 points or higher and 19for defects, with a minimum score 94.The Chicago Mercantile Exchange in its randomlength lumber futures contract has specified thatEach delivery unit shall consist of nominal

s of random lengths from 8 feet to 20 feet, grade-stamped Construction Standard, Standard and Better, or #1 and #2; however, in no case may thequantity of Standard grade or #2 exceed 50%. Each deliver unit shall be manufactured in California,Idaho, Montana, Nevada, Oregon, Washington, Wyoming, or Alberta or British Columbia, Canada,and contain lumber produced from grade-stamped Alpine fir, Englemann spruce, hem-fir, lodgepolepine, and/ or spruce pine fir.

Box 2.3: Specifications of some commodities underlying derivatives contracts

and to certify the quantity and quality of the underlying commodity. The advantage of this systemis that a warehouse receipt becomes a good collateral, not just for settlement of exchange tradesbut also for other purposes too. In India, the warehousing system is not as efficient as it is insome of the other developed markets. Central and state government controlled warehouses arethe major providers of agriproduce storage facilities. Apart from these, there are a few privatewarehousing being maintained. However there is no clear regulatory oversight of warehousingservices.

2.1.3 Quality of underlying assetsA derivatives contract is written on a given underlying. Variance in quality is not an issue incase of financial derivatives as the physical attribute is missing. When the underlying asset is acommodity, the quality of the underlying asset is of prime importance. There may be quite somevariation in the quality of what is available in the marketplace. When the asset is specified, itis therefore important that the exchange stipulate the grade or grades of the commodity that areacceptable. Commodity derivatives demand good standards and quality assurance/ certificationprocedures. A good grading system allows commodities to be traded by specification.

Currently there are various agencies that are responsible for specifying grades forcommodities. For example, the Bureau of Indian Standards (BIS) under Ministry of ConsumerAffairs specifies standards for processed agricultural commodities whereas AGMARK under thedepartment of rural development under Ministry of Agriculture is responsible for promulgatingstandards for basic agricultural commodities. Apart from these, there are other agencies likeEIA, which specify standards for export oriented commodities.

2.2 Global commodities derivatives exchangesGlobally commodities derivatives exchanges have existed for a long time. Table 2.1 gives a list ofcommodities exchanges across the world. The CBOT and CME are two of the oldest derivatives

2.2 Global commodities derivatives exchanges 23

Table 2.1 The global derivatives industryCountry Exchange

United States of America Chicago Board of Trade (CBOT)Chicago Mercantile ExchangeMinneapolis Grain ExchangeNew York Cotton ExchangeNew York Mercantile ExchangeKansas Board of TradeNew York Board of Trade

Canada The Winnipeg Commodity ExchangeBrazil Brazilian Futures Exchange Commodities

and Futures ExchangeAustralia Sydney Futures Exchange Ltd.Peoples Republic Of China Beijing Commodity Exchange Shanghai

Metal ExchangeHong Kong Hong Kong Futures ExchangeJapan Tokyo International Financial Futures Exchange

Kansai Agricultural Commodities ExchangeTokyo Grain Exchange

Malaysia Kuala Lumpur commodity ExchangeNew Zealand New Zealand Futures& Options Exchange Ltd.Singapore Singapore Commodity Exchange Ltd.France Le Nouveau Marche MATIFItaly Italian Derivatives MarketNetherlands Amsterdam Exchanges Option TradersRussia The Russian Exchange

MICEX/ Relis Online St. Petersburg FuturesExchange

Spain The Spanish Options ExchangeCitrus Fruit and Commodity Futures Market ofValencia

United Kingdom The London International Financial FuturesOptions exchangeThe London Metal Exchange

exchanges in the world. The CBOT was established in 1948 to bring farmers and merchantstogether. Initially its main task was to standardise the quantities and qualities of the grains thatwere traded. Within a few years the first futurestype contract was developed. It was know asthe toarrive contract. Speculators soon became interested in the contract and found tradingin the contract to be an attractive alternative to trading the underlying grain itself. In 1919,another exchange, the CME was established. Now futures exchanges exist all over the world. Onthese exchanges, a wide range of commodities and financial assets form the underlying assets in


various contracts. The commodities include pork bellies, live cattle, sugar, wool, lumber, copper,aluminium, gold and tin. We look at commodity exchanges in some developing countries.

2.2.1 AfricaAfricas most active and important commodity exchange is the South African Futures Exchange(SAFEX). It was informally launched in 1987. SAFEX only traded financial futures and goldfutures for a long time, but the creation of the Agricultural Markets Division (as of 2002,the Agricultural Derivatives Division) led to the introduction of a range of agricultural futurescontracts for commodities, in which trade was liberalised, namely, white and yellow maize, breadmilling wheat and sunflower seeds.

2.2.2 AsiaChinas first commodity exchange was established in 1990 and at least forty had appearedby 1993. The main commodities traded were agricultural staples such as wheat, corn and inparticularly soybeans. In late 1994, more than half of Chinas exchanges were closed downor reverted to being wholesale markets, while only 15 restructured exchanges received formalgovernment approval. At the beginning of 1999, the China Securities Regulatory Committeebegan a nationwide consolidation process which resulted in three commodity exchangesemerging; the Dalian Commodity Exchange (DCE), the Zhengzhou Commodity Exchange andthe Shanghai futures Exchange, formed in 1999 after the merger of three exchanges: ShanghaiMetal, Commodity, Cereals & Oils Exchanges. The Taiwan Futures Exchange was launchedin 1998. Malaysia and Singapore have active commodity futures exchanges. Malaysia hostsone futures and options exchange. Singapore is home to the Singapore Exchange (SGX), whichwas formed in 1999 by the merger of two wellestablished exchanges, the Stock Exchange ofSingapore (SES) and Singapore International Monetary Exchange (SIMEX).

2.2.3 Latin AmericaLatin Americas largest commodity exchange is the Bolsa de Mercadorias & Futuros, (BM&F) inBrazil. Although this exchange was only created in 1985, it was the 8th largest exchange by 2001,with 98 million contracts traded. There are also many other commodity exchanges operating inBrazil, spread throughout the country. Argentinas futures market Mercado a Termino de BuenosAires, founded in 1909, ranks as the worlds 51st largest exchange. Mexico has only recentlyintroduced a futures exchange to its markets. The Mercado Mexicano de Derivados (Mexder)was launched in 1998.

2.3 Evolution of the commodity market in India

Bombay Cotton Trade Association Ltd., set up in 1875, was the first organised futures market.Bombay Cotton Exchange Ltd. was established in 1893 following the widespread discontent

2.3 Evolution of the commodity market in India 25

amongst leading cotton mill owners and merchants over functioning of Bombay Cotton TradeAssociation. The Futures trading in oilseeds started in 1900 with the establishment of theGujarati Vyapari Mandali, which carried on futures trading in groundnut, castor seed and cotton.Futures trading in wheat was existent at several places in Punjab and Uttar Pradesh. But the mostnotable futures exchange for wheat was chamber of commerce at Hapur set up in 1913. Futurestrading in bullion began in Mumbai in 1920. Calcutta Hessian Exchange Ltd. was established in1919 for futures trading in rawjute and jute goods. But organised futures trading in raw jute beganonly in 1927 with the establishment of East Indian Jute Association Ltd. These two associationsamalgamated in 1945 to form the East India Jute & Hessian Ltd. to conduct organised tradingin both Raw Jute and Jute goods. Forward Contracts (Regulation) Act was enacted in 1952and the Forwards Markets Commission (FMC) was established in 1953 under the Ministry ofConsumer Affairs and Public Distribution. In due course, several other exchanges were createdin the country to trade in diverse commodities.

2.3.1 The Kabra committee reportAfter the introduction of economic reforms since June 1991 and the consequent gradual tradeand industry liberalisation in both the domestic and external sectors, the Government of Indiaappointed in June 1993 a committee on Forward Markets under chairmanship of Prof. K.N.Kabra. The committee was setup with the following objectives:

1. To assess

(a) The working of the commodity exchanges and their trading practices in India and to makesuitable recommendations with a view to making them compatible with those of other countries

(b) The role of the Forward Markets Commission and to make suitable recommendations witha view to making it compatible with similar regulatory agencies in other countries so as tosee how effectively these agencies can cope up with the reality of the fast changing economicscenario.

2. To review the role that forward trading has played in the Indian commodity markets during the last10 years.

3. To examine the extent to which forward trading has special role to play in promoting exports.

4. To suggest amendments to the Forward Contracts (Regulation) Act, in the light of therecommendations, particularly with a view to effective enforcement of the Act to check illegalforward trading when such trading is prohibited under the Act.

5. To suggest measures to ensure that forward trading in the commodities in which it is allowed to beoperative remains constructive and helps in maintaining prices within reasonable limits.

6. To assess the role that forward trading can play in marketing/ distribution system in the commoditiesin which forward trading is possible, particularly in commodities in which resumption of forwardtrading is generally demanded.


The committee submitted its report in September 1994. The recommendations of thecommittee were as follows:

The Forward Markets Commission(FMC) and the Forward Contracts (Regulation) Act, 1952, wouldneed to be strengthened.

Due to the inadequate infrastructural facilities such as space and telecommunication facilities thecommodities exchanges were not able to function effectively. Enlisting more members, ensuringcapital adequacy norms and encouraging computerisation would enable these exchanges to placethemselves on a better footing.

In-built devices in commodity exchanges such as the vigilance committee and the panels of surveyorsand arbitrators be strengthened further.

The FMC which regulates forward/ futures trading in the country, should continue to act a watchdogand continue to monitor the activities and operations of the commodity exchanges. Amendments tothe rules, regulations and bye-laws of the commodity exchanges should require the approval of theFMC only.

In the context of globalisation, commodity markets in India could not function effectively in anisolated manner. Therefore, some of the commodity exchanges, particularly the ones dealing inpepper and castor seed, be upgraded to the level of international futures markets.

The majority of the committee recommended that futures trading be introduced in the followingcommodities:

1. Basmati rice

2. Cotton and kapas

3. Raw jute and jute goods

4. Groundnut, rapeseed/mustard seed, cottonseed, sesame seed, sunflower seed, safflower seed,copra and soybean, and oils and oilcakes of all of them.

5. Rice bran oil

6. Castor oil and its oilcake

7. Linseed

8. Silver

9. Onions

The liberalised policy being followed by the government of India and the gradual withdrawalof the procurement and distribution channel necessitated setting in place a market mechanism toperform the economic functions of price discovery and risk management.

The national agriculture policy announced in July 2000 and the announcements in the budgetspeech for 20022003 were indicative of the governments resolve to put in place a mechanism offutures trade/market. As a follow up, the government issued notifications on 1.4.2003 permittingfutures trading in the commodities, with the issue of these notifications futures trading is notprohibited in any commodity. Options trading in commodity is, however presently prohibited.


Table 2.2 Volume on existing exchangesCommodity exchange Products Approx. annual vol

(Rs.Crore)

National board of trade, Indore Soya, mustard 80000National multicommodity exchange, Ahmedabad Multiple 40000Ahmedabad commodity exchange Castor, cotton 3500Rajdhani Oil & oilseeds Mustard 3500Vijai Beopar Chamber Ltd. Muzzaffarnagar Gur 2500Rajkot seeds, oil & bullion exchange Castor, groundnut 2500IPSTA, Cochin Pepper 2500Chamber of commerce, Hapur Gur, mustard 2500Bhatinda Om and oil exchange Gur 1500Other (mostly inactive) 1500Total 140000

2.3.2 Latest developmentsCommodity markets have existed in India for a long time. Table 2.3 gives the list of registeredcommodities exchanges in India. Table 2.2 gives the total annualised volumes on variousexchanges. While the implementation of the Kabra committee recommendations were ratherslow, today, the commodity derivative market in India seems poised for a transformation.National level commodity derivatives exchanges seem to be the new phenomenon. The ForwardMarkets Commission accorded in principle approval for the following national level multicommodity exchanges. The increasing volumes on these exchanges suggest that commoditymarkets in India seem to be a promising game.

National Board of Trade

Multi Commodity Exchange of India

National Commodity & Derivatives Exchange of India Ltd


Table 2.3 Registered commodity exchanges in IndiaExchange Product traded

Bhatinda Om & Oil Exchange Ltd. GurThe Bombay Commodity Exchange Ltd. Sunflower oil

Cotton (Seed and oil)Safflower (Seed, oil and oil cake)Groundnut (Nut and oil)Castor oil, CastorseedSesamum (Oil and oilcake)Rice bran, rice bran oil and oilcakeCrude palm oil

The Rajkot Seeds oil & Bullion Merchants Groundnut oilAssociation, Ltd. CastorseedThe Kanpur Commodity Exchange Ltd. Rapeseed/ Mustardseed oil and cakeThe Meerut Agro Commodities Exchange Co. Ltd. GurThe Spices and Oilseeds Exchange Ltd.Sangli TurmericAhmedabad Commodities Exchange Ltd. Cottonseed, CastorseedVijay Beopar Chamber Ltd., Muzaffarnagar GurIndia Pepper & Spice Trade Association, Kochi PepperRajdhani Oils and Oilseeds Exchange Ltd., Delhi Gur, Rapeseed/ Mustardseed

Sugar Grade-MNational Board of Trade, Indore Rapeseed/ Mustard seed/ Oil/ Cake

Soybean/ Meal/ Oil, Crude Palm OilThe Chamber of Commerce, Hapur Gur, Rapeseed/ MustardseedThe East India Cotton Association, Mumbai CottonThe Central India Commercial Exchange Ltd., Gwaliar GurThe East India Jute & Hessian Exchange Ltd., Kolkata Hessian, SackingFirst Commodity Exchange of India Ltd., Kochi Copra, Coconut oil & Copra cakeThe Coffee Futures Exchange India Ltd., Bangalore CoffeeNational Multi Commodity Exchange of Gur, RBD PamolienIndia Limited, Ahmedabad Crude Palm Oil, Copra

Rapeseed/ Mustardseed, Soy beanCotton (Seed, oil, oilcake)Safflower (seed, oil, oilcake)Groundnut (seed, oil, oilcake)Sugar, Sacking, gramCoconut (oil and oilcake)Castor (oil and oilcake)Sesamum (Seed,oil and oilcake)Linseed (seed, oil and oilcake)Rice Bran Oil, Pepper, GuarseedAluminium ingots, Nickel, tinVanaspati, Rubber, Copper, Zinc, lead

National Commodity & Derivatives Exchange Limited Soy Bean, Refined Soy OilMustard SeedExpeller Mustard OilRBD Palmolein Crude Palm OilMedium Staple CottonLong Staple CottonGold, Silver


Solved ProblemsQ: Which of the following feature differentiates a commodity futures contract from a financial futurescontract?

1. Exchange traded product

2. Standardised contract size

3. MTM settlement

4. Varying quality of underlying asset


Q: Physical settlement involves the physical delivery of the underlying commodity at

1. an accredited warehouse

2. the exchange

3. the buyers requested destination

4. None of the above

A: The correct answer is number 1

Q: Typically, in all commodity exchanges, delivery notice is required to be supported by a

1. Letter of credit

2. Warehouse receipt

3. Undertaking

4. Advance payment


Q: Who identifies the buyer to whom the delivery notice is assigned?

1. The exchange

2. The clearing corporation

3. The warehouse

4. The seller


Q: Which of the following exchanges do not offer commodity derivatives trading?

1. National Commodity Derivative Exchange

2. Multi Commodity Exchange of India

3. National Board of Trade

4. National Stock Exchange



Q: On the NCDEX

1. The clearing house assigns delivery to thebuyer

2. The seller assigns delivery to the buyer

3. The buyer chooses which delivery to take

4. The warehouse assigns the delivery to thebuyer


Q: The committee recommended that the Forward Markets Commission(FMC) and the ForwardContracts (Regulation) Act, 1952, need to be strengthened.

1. L C Gupta Committee

2. Kabra Committee

3. Khusro Committee

4. J R Varma Committee


Chapter 3

The NCDEX platform

National Commodity and Derivatives Exchange Ltd (NCDEX) is a technology driven commodityexchange. It is a public limited company registered under the Companies Act, 1956 with theRegistrar of Companies, Maharashtra in Mumbai on April 23,2003. It has an independent Boardof Directors and professionals not having any vested interest in commodity markets. It has beenlaunched to provide a worldclass commodity exchange platform for market participants to tradein a wide spectrum of commodity derivatives driven by best global practices, professionalism andtransparency.

NCDEX is regulated by Forward Markets Commission in respect of futures trading incommodities. 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 inabout 91 cities throughout India at the moment.

NCDEX currently facilitates trading of ten commodities - gold, silver, soy bean, refinedsoy bean oil, rapeseed-mustard seed, expeller rapeseed-mustard seed oil, RBD palmolein, crudepalm oil and cotton medium and long staple varieties. At subsequent phases trading in morecommodities would be facilitated.

3.1 Structure of NCDEX

NCDEX has been formed with the following objectives:

To create a world class commodity exchange platform for the market participants.

To bring professionalism and transparency into commodity trading.

To inculcate best international practices like demodularization, technology platforms, low costsolutions and information dissemination without noise etc. into the trade.

To provide nation wide reach and consistent offering.

To bring together the entities that the market can trust.

32 The NCDEX platform

3.1.1 PromotersNCDEX is promoted by a consortium of institutions. These include the ICICI Bank Limited(ICICI Bank), Life Insurance Corporation of India (LIC), National Bank for Agriculture andRural Development (NABARD) and National Stock Exchange of India Limited (NSE). NCDEXis the only commodity exchange in the country promoted by national level institutions. Thisunique parentage enables it to offer a variety of benefits which are currently in short supplyin the commodity markets. The four institutional promoters of NCDEX are prominent playersin their respective fields and bring with them institution building experience, trust, nationwidereach, technology and risk management skills.

3.1.2 GovernanceNCDEX is run by an independent Board of Directors. Promoters do not participate in the day today activities of the exchange. The directors are appointed in accordance with the provisions ofthe Articles of Association of the company. The board is responsible for managing and regulatingall the operations of the exchange and commodities transactions. It formulates the rules andregulations related to the operations of the exchange. Board appoints an executive committeeand other committees for the purpose of managing activities of the exchange.

The executive committee consists of Managing Director of the exchange who would be actingas the Chief Executive of the exchange, and also other members appointed by the board.

Apart from the executive committee the board has constitute committee like Membershipcommittee, Audit Committee, Risk Committee, Nomination Committee, CompensationCommittee and Business Strategy Committee, which, help the Board in policy formulation.

3.2 Exchange membership

Membership of NCDEX is open to any person, association of persons, partnerships, cooperativesocieties, companies etc. that fulfills the eligibility criteria set by the exchange. All the membersof the exchange have to register themselves with the competent authority before commencingtheir operations. The members of NCDEX fall into two categories, Trading cum ClearingMembers (TCM) and Professional Clearing Members (PCM).

3.2.1 Trading cum clearing members (TCMs)NCDEX invites applications for Trading cum Clearing Members (TCMs) from persons whofulfill the specified eligibility criteria for trading in commodities. The TCM membership entitlesthe members to trade and clear, both for themselves and/ or on behalf of their clients. Applicantsaccepted for admission as TCM are required to pay the required fees/ deposits and also maintainnet worth as given in Table 3.1.

3.3 Capital requirements 33

Table 3.1 Fee/ deposit structure and networth requirement: TCMParticulars (Rupees in Lakh)

Interest free cash security deposit 15.00Collateral security deposit 15.00Annual subscription charges 0.50Advance minimum transaction charges 0.50Net worth requirement 50.00

Table 3.2 Fee/ deposit structure and networth requirement: PCMParticulars (Rupees in Lakh)

Interest free cash security deposit 25.00Collateral security deposit 25.00Annual subscription charges 1.00Advance minimum transaction charges 1.00Net worth requirement 5000.00

3.2.2 Professional clearing members (PCMs)NCDEX also invites applications for Professional Clearing Membership (PCMs) from personswho fulfill the specified eligibility criteria for trading in commodities. The PCM membershipentitles the members to clear trades executed through Trading cum Clearing Members (TCMs),both for themselves and/ or on behalf of their clients. Applicants accepted for admission asPCMs are required to pay the following fee/ deposits and also maintain net worth as given inTable 3.2.

3.3 Capital requirements

NCDEX has specified capital requirements for its members. On approval as a member ofNCDEX, the member has to deposit Base Minimum Capital (BMC) with the exchange. BaseMinimum Capital comprises of the following:

1. Interest free cash security deposit

2. Collateral security deposit

All Members have to comply with the security deposit requirement before the activation oftheir trading terminal. Members can opt to meet the security deposit requirement by way of thefollowing:

Cash: This can be deposited by issuing a cheque/ demand draft payable at Mumbai in favour ofNational Commodity & Derivatives Exchange Limited.


Bank guarantee: Bank guarantee in favour of NCDEX as per the specified format from approvedbanks. The minimum term of the bank guarantee should be 12 months.

Fixed deposit receipt: Fixed deposit receipts (FDRs) issued by approved banks are accepted. TheFDR should be issued for a minimum period of 36 months from any of the approved banks.

Government of India securities: National Securities Clearing Corporation Limited (NSCCL) is theapproved custodian for acceptance of Government of India securities. The securities are valued on adaily basis and a haircut of 25% is levied.

Members are required to maintain minimum level of security deposit i.e. Rs.15 Lakh in caseof TCM and Rs. 25 Lakh in case of PCM at any point of time. If the security deposit fallsbelow the minimum required level, NCDEX may initiate suitable action including withdrawal oftrading facilities as given below:

If the security deposit shortage is equal to or greater than Rs. 5 Lakh, the trading facility would bewithdrawn with immediate effect.

If the security deposit shortage is less than Rs.5 Lakh the member would be given one calendarweeks time to replenish the shortages and if the same is not done within the specified time thetrading facility would be withdrawn.

Members who wish to increase their limit can do so by bringing in additional capital in theform of cash, bank guarantee, fixed deposit receipts or Government of India securities.

3.4 The NCDEX system

As we saw in the first chapter, every market transaction consists of three components trading,clearing and settlement. This section provides a brief overview of how transactions happen onthe NCDEXs market.

3.4.1 TradingThe trading system on the NCDEX, provides a fully automated screenbased trading forfutures on commodities on a nationwide basis as well as an online monitoring and surveillancemechanism. It supports an order driven market and provides complete transparency of tradingoperations. The trade timings of the NCDEX are 10.00 a.m. to 4.00 p.m. After hours trading hasalso been proposed for implementation at a later stage.

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 quantityfields are in units and price in rupees. The exchange specifies the unit of trading and the deliveryunit for futures contracts on various commodities . The exchange notifies the regular lot size andtick size for each of the contracts traded from time to time. When any order enters the tradingsystem, it is an active order. It tries to find a match on the other side of the book. If it findsa match, a trade is generated. If it does not find a match, the order becomes passive and gets

3.4 The NCDEX system 35

queued in the respective outstanding order book in the system. Time stamping is done for eachtrade and provides the possibility for a complete audit trail if required.

NCDEX trades commodity futures contracts having onemonth, twomonth and threemonth expiry cycles. All contracts expire on the 20th of the expiry month. Thus a Januaryexpiration contract would expire on the 20th of January and a February expiry contract wouldcease trading on the 20th of February. If the 20th of the expiry month is a trading holiday,the contracts shall expire on the previous trading day. New contracts will be introduced on thetrading day following the expiry of the near month contract.

3.4.2 ClearingNational Securities Clearing Corporation Limited (NSCCL) undertakes clearing of tradesexecuted on the NCDEX. The settlement guarantee fund is maintained and managed by NCDEX.Only clearing members including professional clearing members (PCMs) only are entitled toclear and settle contracts through the clearing house. At NCDEX, after the trading hours on theexpiry date, based on the available information, the matching for deliveries takes place firstly, onthe basis of locations and then randomly, keeping in view the factors such as available capacity ofthe vault/ warehouse, commodities already deposited and dematerialized and offered for deliveryetc. Matching done by this process is binding on the clearing members. After completion of thematching process, clearing members are informed of the deliverable/ receivable positions andthe unmatched positions. Unmatched positions have to be settled in cash. The cash settlement isonly for the incremental gain/ loss as determined on the basis of final settlement price.

3.4.3 SettlementFutures contracts have two types of settlements, the MTM settlement which happens on acontinuous basis at the end of each day, and the final settlement which happens on the lasttrading day of the futures contract. On the NCDEX, daily MTM settlement and final MTMsettlement in respect of admitted deals in futures contracts are cash settled by debiting/ creditingthe clearing accounts of CMs with the respective clearing bank. All positions of a CM, eitherbrought forward, created during the day or closed out during the day, are market to market at thedaily 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. Theresponsibility of settlement is on a trading cum clearing member for all trades done on his ownaccount and his clients trades. A professional clearing member is responsible for settling allthe participants trades which he has confirmed to the exchange. On the expiry date of a futurescontract, members submit delivery information through delivery request window on the traderworkstations provided by NCDEX for all open positions for a commodity for all constituentsindividually. NCDEX on receipt of such information, matches the information and arrives at adelivery position for a member for a commodity.

The seller intending to make delivery takes the commodities to the designated warehouse.These commodities have to be assayed by the exchange specified assayer. The commoditieshave to meet the contract specifications with allowed variances. If the commodities meet the


specifications, the warehouse accepts them. Warehouse then ensures that the receipts get updatedin the depository system giving a credit in the depositors electronic account. The seller thengives the invoice to his clearing member, who would courier the same to the buyers clearingmember. On an appointed date, the buyer goes to the warehouse and takes physical possessionof the commodities.

Solved ProblemsQ: Which of the following futures do not trade on the NCDEX?

1. Cotton futures

2. Gold futures

3. Silver futures

4. Energy futures


Q: NCDEX is regulated by

1. The Forward Markets Commission

2. SEBI

3. Reserve Bank of India

4. Controller of Capital Issues


Q: The net worth requirement for a TCM is

1. Rs.5 Lakh

2. Rs.50 Lakh

3. Rs.500 Lakh

4. Rs.5000 Lakh


Chapter 4

Commodities traded on the NCDEXplatform

In December 2003, the National Commodity and Derivatives Exchange Ltd (NCDEX) launchedfutures trading in nine major commodities. To begin with contracts in gold, silver, cotton,soyabean, soya oil, rape/ mustard seed, rapeseed oil, crude palm oil and RBD palmolein arebeing offered.

We have a brief look at the various commodities that trade on the NCDEX and look at somecommodity specific issues. The commodity markets can be classified as markets trading thefollowing types of commodities.

1. Agricultural products

2. Precious metal

3. Other metals

4. Energy

Of these, the NCDEX has commenced trading in futures on agricultural products andprecious metals. For derivatives with a commodity as the underlying, the exchange must specifythe exact nature of the agreement between two parties who trade in the contract. In particular, itmust specify the underlying asset, the contract size stating exactly how much of the asset will bedelivered under one contract, where and when the delivery will be made. In this chapter we lookat the various underlying assets for the futures contracts traded on the NCDEX. Trading, clearingand settlement details will be discussed later.

4.1 Agricultural commoditiesThe NCDEX offers futures trading in the following agricultural commodities Refined soy oil,mustard seed, expeller mustard oil, RBD palmolein, crude palm oil, medium staple cotton andlong staple cotton. Of these we study cotton in detail and have a quick look at the others.

38 Commodities traded on the NCDEX platform

4.1.1 CottonCotton accounts for 75% of the fibre consumption in spinning mills in India and 58% of the totalfibre consumption of its textile industry (by volume). At the average price of Rs.45/ kg, over 17million bales (average annual consumption, 1 bale = 170 kg) of raw cotton trade in the country.The market size of raw cotton in India is over Rs.130 billion. The average monthly fluctuationin prices of cotton traded across India has been at around 4.5% during the last three years. Themaximum fluctuation has been as high as 11%. Historically, cotton prices in India have beenfluctuating in the range of 3-6% on a monthly basis.

Cotton is among the most important nonfood crops. It occupies a significant position, bothfrom agricultural and manufacturing sectors points of view. It is the major source of a basichuman need clothing, apart from other fibre sources like jute, silk and synthetic. Today, cottonoccupies a significant position in the Indian economy on all fronts as a commodity that formsa means of livelihood to over millions of cotton cultivating farmers at the primary agriculturalsector. It is also a source of direct employment to over 35 million people in the secondarymanufacturing textile industry that contributes to 14% of the countrys industrial production,2730% of the countrys export earnings and 4% of its GDP.

Cropping and Growth pattern

Cotton is a tropical and subtropical crop. For the successful germination of its seeds, a minimumtemperature of is required. The optimum temperature range for vegetative growth is

. It can tolerate temperatures as high as , but does not do well if the temperaturefalls bellow

C. During the period of fruiting, warm days and cool nights, with large diurnalvariations are conducive to good boll and fibre development. In the case of the rainfed cotton,which predominates and occupies nearly 75% of the area under this crop, a rainfall of 50 cm isthe minimum requirement. More than the actual rainfall, a favourable distribution is the decidingfactor in obtaining good yields from the rainfed cotton. Cotton is grown on a variety of soils. Itrequires a soil amenable to good drainage, as it does not tolerate water logging. It is grown mainlyas a dry crop in the black and medium black soils and as an irrigated crop in the alluvial soils.The predominant types of soils on which the crop is grown are (1)Alluvial soils predominant inthe northern states of Punjab, Haryana, Rajasthan and Uttar Pradesh, (2)The black cotton soils,(3)The red sandy loams to loams predominant in the states of Gujarat, Maharashtra, MadhyaPradesh, Andhra Pradesh, Karnataka and Tamil Nadu, and (4)Lateritic soils found in parts ofTamil Nadu, Assam and Kerala.

Cotton is a 90120 day annual crop. In the main producing countries of USA, China, Indiaand Pakistan, the crop is sown during the JuneJuly period and harvested during September-October. Harvested Kappas (cotton with seed) start arriving into the market (from the producingcentres) from October-November onwards. Kappas are bought by ginners, who separate theseeds from the lint (cotton fibre), a process called ginning (lint recovery from kappas is 3031%). The loose cotton lint so obtained is pressed and sold to the spinning mills in the form offull pressed bales (1 bale = 170 kg cotton lint in India; in USA, it is 480 pounds). Spinned cottonyarn is used by clothe manufacturers/ textile industry.

4.1 Agricultural commodities 39

Global and domestic demandsupply dynamics

China, USA, India and Pakistan top the list of cotton producing countries. Uzbekistan, Brazil,Turkey and Australia are the other major producers. These eight countries produced over 80%of the worlds cotton production during 200102.

China, India, USA and Pakistan top the list of cotton consuming countries. These alongwith Turkey, Brazil, Indonesia, Mexico, Russia, Thailand, Italy and Korea consume over 80% ofthe worlds annual cotton consumption. Global production of cotton during the post 1990 (tilldate i.e. 200203 forecast) has been fluctuating in the narrow range of 16.521 million tons.Similarly, consumption has been in the range in the 1820.5 million tons. The global export andimport trade of cotton during the post 1990 era has been in the range of 5.5 to 6.5 million tons.

Production of cotton in India during the post 1990 period has been fluctuating in the rangeof 1217 million bales (i.e. between 2.22.8 million tons), constituting about 15% of the globalcotton production. Currently, the countrys cotton consumption stands at 17-19 million bales(2.72.9 million tons). Indias position on the global trade front has witnessed a drastic changeduring the post 1995 period. The country has turned from being net exporter to net importer. Thecountrys raw cotton exports, which stood at 1.21.6 million bales during the pre1996 periodhave dipped to less than 100 thousand bales. Contrary to this, the imports have sharply risenfrom 3000050000 bales during the pre1995 to little over 2.2 million bales during the last threeyears. Among several other reasons, it is the lack of availability of desired quality cotton that hasmade many Indian buyers (particularly the export oriented units) to opt for purchases of foreigncotton despite enough domestic supply. Most importing mills in India are ready to pay 510%premium for foreign cotton due to its higher quality (less trash, uniform lots, higher ginningoutturn) and better credit terms (36 months vs. 1530 days for local). Mills using ELS (extralong staple) have been pleased with US Pima and its fibre characteristics. US has emerged as animportant supplier in the last two seasons. Apart from US, India is also importing from Egypt,West Africa, and the CIS countries and Australia on account of lower freight and shorter deliveryperiods.

Price trends and factors that influence prices

Cotton production and trade is influenced by various factors. Production (acreage under thecrop) of cotton varies from year to year based on the climatic factors that are crucial for theproductivity of crop. Cotton trade is influenced by the supplydemand scenario, production andprices of synthetic fibre (polyester, viscose and acrylic) and prices of cotton itself, etc.

The global supply and demand statistics released by the International Cotton AdvisoryCommittee (ICAC) and the United States Department of Agriculture (USDA) periodically areclosely watched by the trading community.

The central government establishes minimum support prices (MSP) for Kappas at the startof each marketing season. The CCI is responsible for establishing the price support in all States.Typically, market prices remain well above the MSP, and CCI operations are generally limitedto commercial purchases and sales (except for a few years like 200102 when the prices wereabysmally low).

40 Commodities traded on the NCDEX platform

Futures prices of cotton at the New York Board of Trade (NYBOT) serve as the referenceprice for cotton traded in the international market. World cotton prices fell sharply during mostpart of 2001, NyBOT witnessing a sharp downfall in prices from 61.78 US Cents/ lb (as on Jan2, 2001) to the low of 28.20 US Cents/ lb (as on Oct 26, 2001), a sharp fall by 54.35%. Towardsmid2002, prices recovered to 53 cents, and toward end of 2003 were currently ruling at 58.85cents.

Cotton prices in India are therefore influenced by various demandsupply factors operatingwithin the country, international raw cotton prices, demand for finished readymade garmentsfrom abroad, prices of synthetic fibre, etc. Jute, silk, wool and khadi the other fibre sources,are less likely to have any major impact on cotton prices in India.

4.1.2 Crude palm oilAnnual edible oil trade in India is worth over Rs.440 billion, with the share of CPO being nearly20% (Rs.80-90 billion). The country is overdependent on CPO imports to the extent of over50% of its annual vegetable oil imports. There is a close inter linkage between the variousvegetable oils produced, traded and consumed across the world. The average monthly fluctuationin prices of imported CPO traded at Kandla (one of the major importing ports in Gujarat) hasbeen at 9.7% during the past two and a half years, the maximum monthly fluctuation being ashigh as 25% during the period.

Palm oil is extracted from the mature fresh fruit bunches (FFBs) of oil palm plantations.One hectare of oil palm yields approximately 20 FFBs, which when crushed yields 6 tons of oil(including the kernel oil, which is used both for edible and industrial purposes). Crude palmoil (CPO), crude palmolein, RBD (refined, bleached, deodorized) palm oil, RBD palmolein andcrude palm kernel oil (CPKO) are the various forms of palm oil traded in the market.

Cropping and growth patterns

Oil palm requires an average annual rainfall of 2000 mm or more distributed evenly throughoutthe year. Rainfall less than 100 mm for a period of more than three months is not suitable foroil palm cultivation. Oil palm thrives well at temperatures of

C with at least 5 hourssunshine per day throughout the year. Oil palm can be grown on a wide range of soil. In general,the soil should be deep, well structured and well drained. However, in areas where rainfall ismarginally suitable, the waterholding capacity of the soil is of greatest importance. Flat orgentle undulating land is preferred. Oil palm is sensitive to pH above 7.5 and stagnant water.

Global and domestic demandsupply dynamics

CPO is used for human consumption as well as for industrial purposes. The consumption ofpalm oil (both food and industrial consumption put together) in the world is growing at the rateof 7.37% compounded annually during the last 12 years period. While in the importing countrieslike China and European Union, the consumption of palm oil is growing at the rate of 5.2%and 4.8% respectively, the consumption growth rate for the worlds leading palm oil importer

4.1 Agricultural commodities 41

(in specific, and edible oils in general), India, stands at 25%. India, China, Pakistan and theEuropean Union are the major importers of palm oil. India is the largest importer of CPO witha share of over 15% of the total quantity traded in the international market. The total importsof India, China, Pakistan and European Union amount to approximately 56% of the total globalexports of palm oil annually.

Production of palm oil stands at 2425 million tons (over 22% of the global vegetable oil).Palm oil dominates the global vegetable oil export trade. The two producing countries viz.Malaysia and Indonesia dominate the global trade in CPO. Their share in the global exportsof CPO is to the tune of 90%. The major trading centres of CPO in the world are Malaysiaand Indonesia in Asia and Rotterdam in Europe. The Kuala Lumpur based Malaysia DerivativesExchange Bhd. (MDEX) could be considered as the price maker of palm oil traded world over.This exchange trades only CPO among several derivatives of palm. The domestic production ofpalm oil forms almost a negligible part of the total edible oil consumption in the country.

Rising consumption of palm oil in India, which could be mainly attributed to its pricecompetitiveness among several of its competing oils is being met through increasing imports.Palm oil supports many other industries in India like refining, vanaspati and other industrialsectors apart from human consumption as RBD palmolein. The major importing and tradingcentres for palm in India are Chennai, Kakinada, Mumbai and Kandla. The other centerslike Mundra, Kolkata, Mangalore and Karwar also play important role, but next to the fourmajor trading centers. Palm oil trade in India is influenced by the supplydemand scene inthe domestic market including the factors influencing various oilseed production in the country,prices of various domestically produced and imported oils, production and trade policies of theGovernment, mainly the exportimport policy, overall health of the economy that has a bearingon the purchasing power of ultimate consumers, etc. The entire industry of CPO in India isdominated by importers, large refiners, corporate involved in wholesale and retail trade throughvalueaddition and retailregional level players along with a few national level players. Theindustry is dominated by over 200 importing companies, who are mostly refiners too. Domesticoilseed and edible oil industry is organised in the form of oilseed crushers, processors, solventextractors, technologists, commodityspecific producers and traders.

Price trends and factors that influence prices

There exists a clear trough and crest in the seasonality of CPO production, indicating a typicalseasonality in the production cycle. The production bottoms down in the months of February,March and April, while the it is at its peak during the months of August, September and October.Palm oil trade is influenced by various production, market and policy related factors. Being aperennial plantation crop, acreage under palm plantation does not vary from season to season.Production is almost evenly distributed throughout the year between 0.81.1 million tons ina monthly. However, it exhibits seasona

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