How to Trade Gold Derivatives in Indian Commodity Markets?

10 min read • Published 29 December 2022
Written by Chandhana Padma
Trade Gold Derivatives in Indian Commodity Markets

Gold is considered one of the most valuable assets in the world. India is the 2nd largest consumer of gold. It has an active stable traditional market for the asset.  Gold has proved to work  well as a hedge against inflation and a safe-haven asset during  economic and/or political crises of sorts.

Numerous commodity traders prefer trading gold over other commodities due to the significantly large volume of contracts written on it, the price of gold is affected by multiple factors, such as supply and demand, GDP, inflation, etc.

In this blog, we will discuss how to trade gold in the Indian commodity markets and then briefly touch on  the  benefits of the same.

Methods of Investing in Commodity Gold

You can invest in commodity gold through  many ways.  Few of these ways are enlisted below:

  • Gold Contracts

Gold contracts are the most popular mode of gold trading/investing. You can purchase them from the Multi Commodity Exchange of India (MCX). These are derivatives (futures and options) that traders can use to speculate on the price movement of gold. This method of gold trading is suitable for seasoned investors who use trading strategies like hedging to protect their investments.

MCX offers four types of gold futures, these are as follows::

  1. Gold- 1 kg
  2. Gold Mini (100 g)
  3. Gold Guinea (8 g)
  4. Gold Petal (1 g)
  • Gold Exchange-Traded Funds (ETFs)

Gold ETFs are similar to stocks in the sense that they are bought and sold continuously on the stock exchange. They are passive funds that track the price of domestic gold in bullions. Each unit of a gold ETF represents 1 gram of 99.5% purity gold. The gold is stored in depositories as the underlying asset from which ETF units get their intrinsic value. 

In India, gold ETFs are listed and traded on NSE’s (National Stock Exchange) and BSE’s (Bombay Stock Exchange). 

Gold ETFs can be purchased on the BSE/NSE via a broker through a Demat account and a trading account. There is a brokerage fee and minimal fund management fee applicable when buying or selling gold ETFs.

  • Sovereign Gold Bonds (SGBs)

SGBs are a type of government security offered by the Reserve Bank of India (RBI). Investors can purchase amounts of gold as low as 1 gram. The maximum limit for purchasing SGBs is 4 kg for individuals andHindu Undivided Family (HUF) and 20 kg for trusts and other entities in a financial year.

The bond’s value is based on the market price of physical gold with 999 purity. After the maturity period, investors can redeem the bonds at the prevalent price and get an interest at a 2.5% interest rate. Interest will be credited semi-annually to the investor’s bank account, and the final interest will be paid with the principal upon maturity.

The trading of SGBs is done at pre-arranged timings arranged by the RBI. The announcement of the SGB series is similar to how initial public offerings (IPOs) are done.

What Are Gold Futures?

Gold futures are one of the most popular methods of trading gold. It is an agreement between two parties to buy and sell gold respectively on a fixed date and time at a mutually pre-decided price. 

Since the inception of commodity exchanges such as MCX and NCDEX, gold futures trading has been taking place. There are presently four types of gold futures, with details provided in the table below.

Product/ParameterGold RegularGold MiniGold GuineaGold Petal
Contract Size1 kg100 g8 g1 g
Quotation Base10 g10 g8 g1 g
Delivery Unit/Delivery1 kg100 g8 g1 g
Delivery LogicMandatory
Tick Size₹1 / 10 g₹1 / 10 g₹1 / 8 g₹1 / 1 g
Expiry Date5th Day of Expiration MonthLast Day of Calendar Month
Profit/Loss per ₹1001011
Initial MarginMinimum 6% or based on SPAN (the one that is higher)
Extreme Loss MarginMinimum 1%

The margins for gold futures keep changing as per exchange requirements and depend on various factors such as volatility. The following table provides an understanding of gold futures margins.

Product/ParameterGoldGold MiniGold GuineaGold Petal
Trading/Delivery Unit1 kg100 g8 g1 g
Price (Assumed)₹50,800 / 10 g₹50,800 / 10 g₹40,600 / 8 g₹5,050 / 1 g
Contract Value₹50,80,000₹5,08,000₹40,600₹5,050
Initial Margin* @ 8%₹4,06,400₹40,640₹3,248₹404

*Margin percentage may change as per exchange requirements

What Are Gold Options?

After the Forward Markets Commission (FMC) underwent a merger with the Securities & Exchange Board of India (SEBI) in September 2015, SEBI introduced options trading for commodity futures. They released the first options contract for gold futures on October 17 2017. 

Options are derivatives in which two parties agree to carry out a transaction on a certain date and at a mutually agreed price. , the option-holder is not obligated to carry out the trade.  In gold options, the underlying asset securing the transaction is  gold future(s).

The table given below provides relevant parameters of the options contract.

Expiry Date8 business days before the expiry of underlying
Tick Size (Minimum Price Movement)₹0.50
Underlying Price QuoteEx-Ahmedabad
Underlying Quotation / Base Value₹ / 10 g
Strike Price Intervals₹100
Daily Price LimitThe Black and Scholes Options pricing model determines the upper and lower price bands. 
SettlementUpon the options’ expiry, its open position shall devolve into an underlying futures position as follows:A short call position will devolve into a short position in the underlying futures contract.A short put position will turn to a long position in the underlying futures contract.A long call position shall devolve into a long position in the underlying futures contract.A long put position shall devolve into a short position in the underlying futures contract.

How to Start Trading in Gold Futures?

While learning how to trade gold, you must know the basic steps involved in trading futures. These steps are discussed below.

Step 1: Open an account with a SEBI-registered broker. Complete all account opening formalities, such as submitting the application form and completing KCby providing all needed documents, such as ID and address proof, bank account info, photographs, etc.

Step 2: After your account is verified, deposit the initial margin required with the broker to trade. You can find details on margin requirements in the gold futures documentation.

Step 3: Deposit a maintenance margin in case your deposited initial margin reduces due to accumulation of losses.Abiding by the above mentioned,you can trade gold on MCX from 9:00 AM – 11:30 PM, from Monday to Friday.

You must activate the commodity segment in your broker interface to trade MCX gold if you already have an equity trading account. You must submit any of the following documents to activate the commodity segment.

  • Salary Slip
  • Mutual Fund Statement
  • Last 6 Months Bank Statement
  • ITR Acknowledgement
  • Form 16
  • Demat Account Holding Statement
  • Bank Fixed Deposit Receipt

Factors Affecting Prices of Gold and Gold Futures

Knowing the factors that move gold prices prior to making investments in it is crucial. You can learn how to trade gold properly by understanding the below mentioned factors: 

  • Supply and Demand

While some countries like China andRussia are significant producers of gold, others are primarily importers. India is one such country that  primarily imports gold. As a result, there is a high demand but limited supply, which leads to heavy price fluctuations of the commodity.

  • Mining and Distribution Costs

Since India imports gold from other countries,  additional costs associated with mining, refining, transporting and distributing physical gold are levied by exporters. Any change in these cost centres will affect the price of gold and gold derivatives. Recently on account of mining companies having to incrementally invest in human resources  there was a surge in prices of gold and gold derivatives.

  • Value of the US Dollar

All cross-border payments for gold transactions are made in US dollars. Hence there exists a correlation between gold prices and the value of the US Dollar – demand for gold becomes higher when the USD weakens. investors tend to protect their capital when the USD falls by investing in gold rather than other riskier assets.

  • Interest Rates

Gold prices rise due to high demand when market interest rates are low; gold is inversely proportional to market interest rates. When the cost of borrowing is low, borrowing activity rises and subsequently so does the demand for gold. The upsurge in demand drives gold prices higher in environments’ of low rates of interest.Similarly, when interest rates are high, the demand for gold becomes lower, and investors tend to invest in fixed-income instruments for inflation-adjusted returns as a consequence.

  • Central Banks

Central banks across the world keep gold reserves as a means to maintain the value of the national currency. RBI is expected to maintain a minimum of ₹200 crores gold before printing new currency.Requirements such as this might drive the prices of gold and gold derivatives up and down.Geopolitics

During geopolitical tensions, people prefer investing in gold since it is perceived to be a store of value. Even if a given country’s currency depreciates, gold retains its value. Hence, amidst geopolitical turmoil the demand and price of gold and gold derivatives  goes up.

Benefits of Investing in Gold Derivatives

While learning how to trade  gold  derivatives, it is essential to know the benefits. The most important benefits of gold futures and options are mentioned below.

  • Purity

Gold futures are backed by 24 carat gold, the purest form of gold.  while purchasing physical gold however, you may not always get this benefit, as physical gold is sold in less pure forms.

  • Liquidity

Gold derivatives are highly liquid assets, much more liquid than physical gold. You can sell them within minutes with no hassle as the purity is assured. However, in the case of physical gold, you would have to visit a gold jeweller or merchant who will most often  make deductions mostly on account of purity while calculating the value of the transaction. 

  • Safety and Storage

Physical gold comes with the burden of storage. One would have to store gold at home or in a bank locker that entails annual charges.. There is always an enhanced innate holding risk when it comes to physical gold.Much of the storage burden  is eliminated with gold derivatives since they are dealt with in electronic demat accounts entailing much lower costs.

  • High Leverage

You can purchase gold futures at a fraction of the actual cost through the instrumentality of high-leverage facilities. The fractional amount paid to enter the transaction is known as the initial margin.

Final Word

Similar to all investments, gold investments also require thorough knowledge and detailed analysis of one’s financial goals and risk tolerance. It is prudent to analyse the markets thoroughly before making investment choices such as this.

Frequently Asked Questions

What is the tick price in gold futures?

Tick price is the minimum price difference that  exists at all times between consecutive bid and offer prices.  It is the minimum increment at which gold prices can change. The increment cannot be less than the tick price.

What is the strike price in gold options?

The strike price in gold options is the price at which you can exercise the put or call option. It is also known as the exercise price.

Are there any risks related to gold investment?

The primary risk that comes with gold investment is the same risk that comes with all commodities andThat is the negative correlation with  a major fraction of broader market movements.

How does inflation affect the price of gold?

Gold is a safe-haven asset; its value therefore increases during inflationary periods. As the prices of goods and services increase, more people purchase gold. inflation usually affects the value of currencies, and this further adds to the demand for gold (a perceived store of value).

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Chandhana Padma

Investment Associate
Chandhana is a budding investment professional with growing expertise in the capital markets. She has completed her Bachelors in Business Administration with a specialisation in Finance from Christ (deemed to be) University,Bangalore. She is also a CFA L2 candidate. She is currently working as an Investment Associate at Wint Wealth.

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