Commodity Analysis

Lessons on commodity trading

?Bavadharini KS | Updated on September 20, 2020 Published on September 20, 2020

Different commodities are available at different contract sizes. You can trade based on your risk appetite and trading capacity

If you are an importer/exporter or broker or a company looking to hedge price risks in the commodities market, you can take a suitable position in a suitable commodity.

What if you are an investor looking to diversify into commodities trading?

There is a range of commodities such as metals and precious metals that you can trade in.

Trading in commodities is mostly through commodity derivatives — futures and options. The trading happens on a commodity exchange.

There are three major commodity exchanges in the country — Multi Commodity Exchange of India (MCX), National Commodity and Derivatives Exchange (NCDEX) and Indian Commodity Exchange (ICEX).

Each of them has different commodities to trade. For the last one-two years, NSE and BSE, too, have been offering contracts in commodities. Here is what you should know about the contracts traded across commodity exchanges.

Options are vast and wide

Across the exchanges, various commodities, including metals, precious metals, agriculture products and energy contracts, are being traded, and each exchange is renowned for certain commodities.

MCX is a major player in metals such as copper, aluminium and zinc; precious metals — gold and silver — and energy contracts such as crude oil and natural gas.

Among these, only gold and silver have multiple contracts in different trading units. Let us consider gold for instance.

Gold is widely traded mostly on MCX, and the exchange offers four different futures contracts ranging from 1 gram to 1 kg for delivery — gold (1 kg trading units), gold mini (100 grams), gold guinea (8 grams) and gold petal (1 gram).

MCX has both futures and options across all commodity categories. However, the options trading is available only for copper, crude oil, zinc gold and gold mini, silver and silver mini contracts. MCX also has agriculture commodities for trading (futures contract), including crude palm oil, cotton and black pepper. Recently, the exchange launched futures trading in bullion index (MCX iCOMDEX Bullion Index).

In addition to MCX, BSE (futures/options) and NSE (futures), too, have bullion contracts, both gold and silver.

NSE also has brent crude oil futures contracts.

When it comes to NCDEX, it is mostly known for its agriculture commodities, including cereals and pulses such as chana, bajra, barley and wheat; oil and oil seeds such as castor seeds and cotton seed oil cake; and spices such as pepper and turmeric. The exchange’s contracts (futures/options) are available for trading in only one variant. That is, if you as a trader, dealer or broker considering chana future contract, it is available in a trading unit of 10 tonnes only.

Similarly, castor seed futures contract is available for 5 tonnes only. NCDEX also has launched futures contracts on its agri-commodity index, AGRIDEX. It also has options contract in agri-commodities such as chana, mustard seed and soysbean.

On ICEX commodities, futures, including diamonds, steel and rubber contracts, are traded.

How to choose?

Different commodities are available for trading at different sizes, particularly in precious metals.

You can trade in different contracts based on your risk appetite and trading capacity.

For instance, if you want to position for a lower amount in gold contracts, there are multiple choices available on MCX. One lot of gold petal contract on MCX, which is 1 gram, costs ₹5,191 currently, while gold contracts, 10 grams is around ₹51,915.

Keep in mind the volumes and bid-ask spread (especially in options contract) of the commodities you plan to take position. The bid-ask spread is basically the difference between the highest price that a buyer is willing to pay for an asset and the lowest price that a seller is willing to accept.

It is an indication of liquidity in the market for that commodity.

For instance, let’s consider the gold options on MCX, the bid price is ₹523 and the ask price is ₹534, here the difference between the bid and the ask is ₹11. If you take futures contract of gold, the bid and ask price is ₹51,953 and ₹51,958 (difference is ₹5).

The narrower the difference, the better the liquidity.

Another important point to note is that derivatives contract of all commodities, except energy commodities, are compulsory delivery contracts.

It means that if you hold a buy (or sell) position on expiry, you are liable to take physical delivery (or deliver the physical commodity to the buyer) of the commodity. So, it is very important to square off, that is, liquidate the open trade before expiry, if the intention is not to take physical delivery of the commodity.

Also, understand the cyclical nature of the commodities; in case of agri-products, factors including monsoon, harvest and policy/regulation changes should also be taken into consideration while trading.

Study the commodity market to avoid unnecessary risk and losses.

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Published on September 20, 2020
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