Derivatives

MCX unveils bullion index futures

?Bavadharini KS | Updated on August 23, 2020

It helps investors who want to access the bullion futures market with relatively low risks

The MCX will launch the country’s first bullion index futures contract — MCX Bulldex — on August 24. The futures contract tracks MCX iCOMDEX Bullion Index (which was launched in December 2019).

Bulldex contracts are cash-settled as it is not possible to physically deliver an index.

The launch of bullion index futures comes at a time when investors are looking at bullion, especially gold, as an asset to hedge against inflation and as a safe bet during economic downturns.

While direct investment in commodity futures contracts are rewarding, it comes with downsides. These futures contracts involve high risks, and they are subjected to volatility and are compulsory physical delivery contracts. So, for those investors who want to access the commodities futures market with relatively low risks, the commodities index futures will be of help.

Here is what you should know about the bullion index futures.

MCX’s Bulldex will be traded Monday through Friday between 9 am and 11:30/11:55 pm, based on US daylight savings time period.

There are three contracts available for trading expiring on August, September and October 2020. The minimum price movement (tick-size) is ₹1 and the minimum trading unit is one lot, which is ₹50 multiplied by the MCX iCOMDEX Bullion Index.

While the maximum order size is eight lots, the maximum allowable open position for individual investor is 1,000 lots or 5 per cent of market wide open position, whichever is higher for all MCX iCOMDEX Bullion index futures contracts combined.

Like any other futures contracts, Bulldex contracts, too, come with an initial margin of five per cent or an initial margin based on the value at risk over a three-day horizon, whichever is higher. The exchange also collects an extreme loss margin of 1 per cent in case of high volatility.

The daily price limit will be +/- 3 per cent. If there is a breach in this base limit, relaxation will be allowed up to +/- 6 per cent without a cooling off period. If there is a further breach, this limit shall be further relaxed to up to 9 per cent, after a cooling off period of 15 minutes.

Now, if there is a breach beyond 9 per cent, the price limit of the index futures may be further relaxed in steps of 3 per cent and the same will be informed to the regulator.

Do keep in mind that the exchange levies additional or special margin on all outstanding positions (on buy/sell side) at a percentage as deemed fit.

About bullion index

MCX’s bullion index has gold (1 kg) and silver (30 kg) near-month futures contract as underlying, and the value of the index fluctuates based on these underlying commodities, similar to any stock indices.

The weights of gold and silver for 2020 are 70.52 per cent and 29.48 per cent, respectively; these weights are revised annually.

Since its launch in December 2019, the bullion index has gained nearly 37 per cent until August 19 this year.

For bullion index futures contracts, the MCX iCOMDEX bullion index is the underlying.

Sriram Iyer, Senior Research Analyst, Reliance Securities, said: “The movement of the underlying bullion index depends on the gold and silver futures contract. So, the rough calculation is, for every ₹10 movement of gold, the index movement will be close to 2.38-2.40 points, and for every ₹10 movement in silver futures, the index movement will be close to 0.6 points. The overall movement in the index, if gold and silver both move ₹10, will be close to 3 points.”

Pros and cons

MCX’s bullion futures come with two key benefits. One, these contracts are cash-settled.

This relieves the participants, including traders and other investors, of the need to take physical delivery of commodities, as is the case with every futures contract in commodities market.

Cash-settled contracts attract more participation from traders, hedgers, importers/exporters and other investors. For instance, consider MCX’s crude oil contracts which are cash settled.

The volumes are significantly higher than gold and silver. In January 2020 (before the oil crash in April), the volume was at 4.11 crore while bullion (gold and silver) for the same period was 2.96 crore.

Iyer says: “These index futures contract, without the burden of taking delivery and the costs associated with the same, can encourage retail participation over time.”

The second advantage is on the margin front. In a commodities futures contract, if you, as an investor or a trader, are looking to hedge, you will have to pay initial margin and extreme loss margin, which are usually high.

Faisal Mohammed, Business Analyst at Zerodha, said: “In the case of bullion index futures contract, the margin requirement works out to be lower, around 6-8 per cent, while the margin requirement of a gold futures is around 12 per cent and for silver, it’s around 22 per cent.

“The margin requirement is lower in bullion index futures because it is an index with multiple compositions which sometimes tend to hedge each other, and the volatility of contracts is low comparatively.”

On the downside, derivative products are slightly more complicated than stocks, and lack of knowledge on the operations could lead to losses.

Published on August 23, 2020

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