RINGSIDE VIEW. Commodity investments: Retail investors must study index movements before dabbling in futures trade

In what could be music to the ears of commodity investors, market regulator SEBI last week allowed exchanges to launch futures trading on commodity indices.

According to SEBI, exchanges that are planning to launch trading in the indices, while seeking approval from the regulator, need to submit index data for the past three years constructed along with data on monthly volatility, rollover yield for the month and monthly return.

The trading hours of index futures will be in line with those of index constituents’ futures trading. However, on expiry day, the index futures contract will expire at 5 pm, SEBI said.

The constituents of the commodity index should have had futures contracts on the exchange for at least the previous 12 months and they should have been traded for at least 90 per cent of the trading days during the previous 12 months.

The average daily turnover of the constituent futures contracts during the previous 12 months should be at least ₹75 crore (for agricultural and agri-processed commodities) and ₹500 crore (for all other commodities).

Constituents with at least 80 per cent combined weightage in the index have to meet the average daily turnover criteria; constituents that fail to meet the turnover criteria should not have weightage of over 15 per cent in the index.

However, SEBI said the turnover criteria will not apply to sectoral indices provided exchanges ensure that constituent futures have adequate liquidity.

Besides, to ensure that no single commodity dominates an index, the maximum weightage for any index constituent in a composite index has been capped at 30 per cent.

At a time when gold prices are at a high, this is a welcome move for investors who wish to take calculated risks as they can now have an exposure to an index instead of investing directly in gold futures.

This will also allow fund managers and large investors to spread their risk by investing across various asset class such as equity, bond and commodities to mitigate their risk. However, retail investors should bear in mind that the commodity market poses high risk due to higher volatility. Besides, prices of commodities often move in an opposite direction compared to asset classes such as equity.

In order to acquire a better understanding, retail investors must ideally study index movements for at least six months to one year before venturing into trading on these products.

If one goes by the current trend on the equity derivatives market, trading on index futures accounts for less than 1 per cent, while index options dominate, with an almost 94 per cent share. While trading on index futures is the first step, SEBI might soon allow the launch of commodity options. That could be the real game-changer.

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