Types of Commodities Traded in the Commodity Derivatives Market
While many people prefer to invest in stock markets, experienced investors with specific knowledge opt for commodity trading to earn higher returns. There are different types of markets where traders can buy/sell commodities. While spot markets allow the trading of physical commodities, the commodity derivatives market allows the trading of commodity futures and options.
People can trade various types of commodities in these markets and make profits depending on the price movements of commodities. Commodity trading usually occurs on commodity exchanges like National Commodity and Derivatives Exchange (NCDEX), Multi Commodity Exchange (MCX), National Multi Commodity Exchange (NMCE), Indian Commodity Exchange (ICEX) and Universal Commodity Exchange (UCX)).
Read this blog to get an idea about commodity derivatives trading in India.
Also Read: Trade in the Indian Commodity Markets
What Are Commodities?
First, let us briefly understand what commodities are. A commodity is defined as raw materials, such as oil, pulses, spices and metals, used to produce finished goods. These are used to manufacture goods that people use in their everyday lives or for consumption. Commodities are produced and traded in bulk quantities.
A commodity market is a financial market where producers, wholesalers, manufacturers and traders can purchase and sell commodities and commodity derivatives. Traders use this market as a price discovery mechanism for different commodities. They can choose to trade physical goods or sign a contract to purchase/sell a commodity in the future at a certain price and time for making profit. While hedgers (producers, manufacturers, etc) enter into future contracts for mitigating their risk exposures.
Types of Commodities Traded in India
A large number of commodities can be traded in the commodities derivatives market. These can be broadly classified into agricultural and non-agricultural products. The table below represents the various sectors and commodities that are traded in India:
|Agriculture||Grains: Rice, Basmati rice, wheat, maizePulses: Chana, tur dal, yellow peas, uradOil/Oilseeds: Soy seeds, castor seeds, mustard seeds, castor oil, crude palm oil, groundnut oil Spices: Jeera, red chilli, turmeric, cardamom|
|Precious Metals||Gold, silver, platinum and palladium|
|Materials||Bulk Commodities: Coking coal, iron ore, steel, bauxiteBase Materials: Copper, aluminium, nickel, zinc, tin Others: Rare earth metals, soda ash, chemicals|
|Energy||Natural gas, crude oil, thermal coal, Brent crude, alternative energy|
How Does the Commodity Derivatives Market Work?
Over the past 15 years, the Indian commodities market has undergone massive growth, and as a result, the country holds an important position in the international trade of commodities. As mentioned above, buyers and sellers can trade commodities either in the spot market or the derivatives market.
In the derivatives market, buyers and sellers use standardised contracts to trade commodities. Derivatives are financial contracts that derive their value from underlying assets, which can be a commodity. There are two main types of commodity derivatives- futures and options. These derivatives are traded on commodity exchanges.
There are two factors influencing the demand and supply of a particular commodity:
- Demand in Domestic/International Market: When there is an increase in demand in the domestic/global market, it affects the prices of commodities. It results in a shortage in supply.
- Raw Materials: A shortage of raw materials results in a high price of a commodity. But it will be less if raw materials are readily available.
Different Ways of Commodity Trading
Discussed below are the two important ways through which you can trade in commodities:
- Futures Contract
It is described as an agreement between buyer and seller to buy or sell a predetermined quantity of a commodity at a certain price on the futures contract’s expiry date. With futures, the holder has a binding obligation to execute the trade as per predetermined terms.
- Options Contract
You can use an options contract to trade in commodities. The basic concept of an options contract is that the buyer of the options contract has the right but not a legal obligation to purchase or sell the asset at a pre-fixed price. However, the seller of the options contract is obliged to buy/sell, should the buyer exercise his/her right.
It helps traders to earn profits based on the commodities’ price fluctuations without actually buying or selling those commodities.
Major Commodity Exchanges in India
Detailed below are the important commodity exchanges of India:
|Name of Commodity Exchange||Commodities Traded||Year of Establishment|
|National Multi Commodity Exchange (NMC)||Gold, copper, aluminium, mustard, coffee, jute, rubber etc.||2002|
|Multi Commodity Exchange of India (MCX)||Metal, energy, bullion, pulses, petrochemicals, cereals, etc.||2003|
|National Commodity and Derivatives Exchange Ltd (NCDEX)||Oil, seeds, crude oil, copper, steel, fibres etc.||2003|
|Indian Commodity Exchange (ICEX)||Lead, copper, gold, silver, soybean, natural gas etc.||2009|
|Universal Commodity Exchange (UCX)||Soybean, mustard, turmeric, chana etc.||2013|
Also Read: 5 Reasons to Trade in Commodities
Participants of the Commodity Market
The main participants in the commodity market can be broadly grouped into risk-takers and risk-givers. Risk givers are hedgers who are exposed to risk because of physical exposure to a commodity, and they adopt a sell or buy position on the exchange to mitigate risk.
On the other hand, risk takers (Financial Investors and Arbitrageurs) do not have physical exposure to the commodity but have the risk tolerance to adopt a buy or sell position to earn profits.
Given below are the details of different types of commodity investors:
Producers and manufacturers of commodities who enter a commodity futures contract to reduce their risk exposure are classified as hedgers. Hedgers make sure that they’ll receive a particular price for their products in the future and not incur a loss even if the prices drop.
- Financial Investors
Financial investors include day traders, market makers and position traders who don’t have a position in a physical market and accept risks of losses to benefit from positive changes.
Arbitrageurs are investors who wish to earn risk-free profits by purchasing and selling commodities across various markets simultaneously to benefit from price differences.
Also Read: Role of Commodity Markets in India
Benefits of Trading Commodity Derivatives
Detailed below are the benefits of commodity trading:
- Counterparty risk is either absent or minimal. To protect investors, commodity exchanges in India have put proper risk management guidelines in place.
- The commodity market tends to have a negative correlation with the wider equity and bond markets. Investors can diversify their portfolios by investing in this unique asset class.
- Another crucial benefit is the low margins of commodity futures contracts. It encourages smaller traders to use commodity trading for higher leverage and hedging risks.
- Trading in commodities is an effective way to deal with rising inflation as prices of some of the top commodities, such as gold and silver, increase over time. It helps people to ensure the multiplication of their corpus in the long run.
Commodity trading is occupying an increasingly important position in the Indian financial market. However, you need to understand its nuances and thoroughly analyse your risk profile before investing in it. To help you get started, we have provided some crucial details related to the types of commodities traded in the commodity derivatives market in India.
Frequently Asked Questions
What is the need to regulate the commodity derivatives market in India?
SEBI regulates the commodity derivatives market in India. Regulations ensure transparency, fairness in trading and proper management of commodity exchanges and promote the interests of the various stakeholders.
What are the crucial factors that affect commodity price movements?
Demand and supply of the commodity, weather, seasonality, geo-political developments, currency movements and macro-economic developments are some of the crucial factors that determine price movements in the commodity derivatives market.
What are the different expenses associated with commodity trading?
Different expenses involved with commodity trading are as follows—brokerage charges, Commodity Transaction Tax, SEBI Turnover Fee, Stock Exchange Transaction Charges, Stamp Duty, GST and other charges.
What are basic commodities?
Basic commodities are products that play an important role in people’s daily lives. A few examples include wheat, rice, pulses, oil, etc.