Commodity vs Equity Derivatives Market
Commodity and equity derivative markets are two different types of financial markets that are used for different purposes. Commodity derivatives are used to hedge against price risk in the physical commodity markets, while equity derivatives are used to hedge against price risk in the stock markets. Let us understand the key differentiating factors between equity and commodity derivatives.
1.Number of products:
Equity derivatives have hundreds of scrips spreading in various categories such as banking, IT, FMCG, pharma, infrastructure, vehicle etc. whereas commodity derivatives are very limited categorized into bullion, energy, metals and agri products.
2.Nature of the product:
Equity refers to an investment that is invested into a firm or a listed entity to acquire ownership and share profits. A commodity refers to a basic and undifferentiated product on which traders can invest or take positions.
Equity derivatives price movement is based on Corporate action, dividend announcement, stock splits, bonus shares and Management performance. Commodity derivatives price movement is based on supply-demand, monetary and fiscal policy, tariffs and duties, international trade policies and seasonality.
The equity derivatives contact size is small compared to commodity derivatives. The size of the equity derivatives ranges between Rs. 5 lakhs and Rs. 10 lakhs while the commodity derivatives contract size ranges between Rs. 5000 and Rs. 50 lakhs.
Though equity derivatives contract size is smaller compared to commodity derivatives, the initial margins in equity derivatives is high in the range of 15% to 50% while in commodity derivatives, it is in the range of 6%-20% (percentages are subject to change as per market conditions and scrip).
The trade timing in the Indian equity derivatives market is between 9.15 AM to 3.30 PM while the commodity derivatives trading hour is longest from 9.00 AM to 11.30 / 11.55 PM. Since the commodity derivatives in the Indian exchange are linked to international market, the extended trading hours is to capture international price movement on the same day.
7.Availability of contracts:
The number of contracts in equity derivatives is restricted to three months only while commodity derivatives are available for 12 months in a row making it most attractive price risk management platform for hedgers.
8.Settlement of contracts:
Equity derivatives contracts are settled in the cash while commodity derivatives are having three types of settlement namely compulsory delivery, intention matching and seller’s options. Investors or traders having open position upon expiry of the commodity contracts are obliged to give/take delivery of physical product.
9.Expiry of contract:
The equity derivatives expire on the last Thursday of the contract month while commodity derivatives are having different expiry dates.
Commodity derivatives markets are also subject to stricter regulations than equity derivatives markets, due to the potential for manipulation and other forms of fraud in the physical commodity markets. For example, commodity derivatives markets are subject to position limits, which limit the number of contracts that a single trader can hold. They are also subject to government intervention to prevent unscrupulous trading by section of market participants. In contrast, equity derivatives markets are subject to less stringent regulations.
In conclusion, commodity and equity derivative markets are both financial markets where derivatives are traded. However, the underlying assets, the type of participants, and the nature of these two products are quite different. Commodity derivative markets deal with physical commodities, while equity derivative markets deal with stocks and stock indices. Commodity derivative markets are dominated by producers, consumers, and speculators, while equity derivative markets are dominated by investors and traders. Commodity derivatives markets have been more mature and bigger than equity derivatives, primarily due to the centuries old practice of farmers and merchants who have used futures and options to hedge against the risks of fluctuating prices.
Disclaimer: ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. 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. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investments in securities market are subject to market risks, read all the related documents carefully before investing. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.