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Commodity Trading

Most people have the view that commodity markets are very complex and difficult to understand. This is a myth. It is important that one understands few basic terms before start trading in commodities. Some of the basic terms are: - 

  • Commodities 

  • Commodity Derivatives  

  • Commodity Exchange  

  • Trading Account          

Types of Commodities Traded 

Commodities could be traded at an exchange by way of derivative instruments like Futures and Options. Futures and options are synthetic financial instruments that are based on an underlying, i.e., they derive their value from an underlying instrument. In case of commodity derivatives, the underlying is a commodity. 

Commodities are usually classified into four segments. These are as follows:  

  • Metal commodities: This segment includes various non-precious metals that are mined or processed from the mined metals such as copper, brass, iron, steel, etc. 

  • Precious Metals: Also known as Bullion and Gems: This segment predominantly consists of precious metals like gold, silver, etc.  

  • Energy commodities: This segment includes commodities that serve as major energy sources. Crude oil, natural gas etc. are examples of energy commodities.  

  • Agricultural Commodities: These are generally perishable agricultural products such as soybean, cotton, chana, maize, sugar, guar seed etc. Processed agricultural commodities like soybean oil, palm oil, guar gum etc. are also considered as agricultural commodities. 


Commodity Derivatives

A commodity derivative is a financial instrument that provides an opportunity to trade in different commodities at an exchange. A commodity derivative could either be a Futures or an Options contract.  

The commodity acts as an underlying instrument in both Futures and Options.  It could be any commodity, i.e., an agricultural commodity or non-agri commodity like base metals, precious metals, or crude oil.  

Futures contract in commodity means a binding agreement between two parties to trade a specific amount of a commodity at a specific price on a specific date in the future. In the futures markets, this future date is referred to as the “settlement day.”. Similarly, an Options contract in a commodity provides an opportunity to trade a specific amount of commodity but without any obligation to the buyer of an Options contract.  

Use of Commodity Derivatives

A commodity derivative contract could be used for varied purposes. A participant in a derivatives market could be a hedger, trader, or an arbitrageur. Let’s understand the meaning of each of these terms. 

  • Hedging: To reduce risk due to price fluctuations in the spot market. 

  • Trading: To anticipate the future price movement and take suitable position in the futures market with an intent to make a profit. 

  • Arbitraging: To earn riskless profit by buying and selling in different markets at the same time to profit from price discrepancies. 

Steps to trade in Commodity Derivatives  

Trading in commodity derivatives could be undertaken only through a SEBI registered broker (like ICICI Securities) and the broker should be a member of a recognized commodity exchange. MCX is a recognized commodity exchange in India.  

Following steps need to be undertaken to start trading in commodity derivatives: - 

  • Open a Trading Account. 

  • Register in Commodity Derivatives Segment. 

  • Complete the process of Know Your Client (KYC). 

  • Understand the contents of Risk Disclosure Document (RDD). 

  • Receive /check the allotment of Unique Client Code (UCC) by the Commodity Exchange. 

  • Open a Bank account for funds transfer/receipt. 

  • Deposit/ transfer required Margin in the commodity segment. 

  • Place order in Commodity Futures or Options. 

 Commodity derivatives provide an excellent means of portfolio diversification. For example, gold prices have historically shown a low correlation with most other asset prices (such as equities) and thus offer an excellent means for portfolio diversification as well as for inflation hedging.  



Disclaimer:

ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Centre, H. T. Parekh Marg, Churchgate, Mumbai - 400020, India, Tel No : 022 - 2288 2460, 022 - 2288 2470. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and I-Sec is a Member of Multi Commodity Exchange of India Ltd (Member Code:56250 and having SEBI registration no. INZ000183631. Name of the Compliance officer (broking): Mr. Anoop Goyal, Contact number: 022-40701000, E-mail address: complianceofficer@icicisecurities.com. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. Please note Brokerage would not exceed the SEBI prescribed limit.