Frequently Asked Questions on Commodities Trading

Commodity trading can be defined as the process of buying and selling a range of raw materials or products – from agricultural to energy resources, crude oils, precious metal bullion, etc. This trade takes place through futures and options derivative contracts, wherein the commodity derives its value from an underlying asset – the commodity being traded. Commodities are usually traded in lots, and sellers can take physical delivery of the products traded or settle the trade in cash.

Commodity market traders use Futures and options commodity trading contracts. Traders who enter into futures contracts agree to buy or sell commodities on a fixed, future date, at a fixed price, irrespective of the commodity's market price on the contract maturity date. Traders can also enter into options contracts with more or less the same conditions as the futures contract. However, commodities options traders have the right or option to exit the trade if it does not prove profitable. Such traders must pay a margin while entering into the contract and forfeit the margin if they choose to exit the contract.

Commodity Trading in India involves several agricultural commodities and natural resources. Agricultural commodities are known as soft commodities, whereas natural resources that are mined or extracted are known as hard commodities. The different types of commodities traded in India include Gold and Silver Bullion, Base Metals, Energy Resources, Spices, Agricultural commodities, Oils, Food Grains, etc. Note that not all commodities are traded on every exchange.

Commodity trading proves beneficial in several ways. Firstly, traders benefit from the inflation of commodity prices. During inflation, the cost of commodities and raw materials increase substantially, which helps commodity traders book maximum profits. Traders can also hedge their commodity portfolios against a declining USD and save their assets. Furthermore, they can take advantage of various socio-economic and geopolitical events and uncertain global and economic periods, during which time the supply of goods is constricted. They can speculate or hedge their trades and book significant profits resulting from shortages.

Traders can derive the following benefits of commodity trading:

• Commodity trading allows investors to diversify their investment portfolios by adding a different asset class to them.

• Commodities assist traders in hedging their investments against inflation since the prices of commodities typically rise during high inflation periods. Hedging allows investors to maintain their purchasing power parity.

• Geopolitical events like natural disasters, economic crises, wars, etc., lead to scarcity of commodities, and by extension, increased prices. Trading commodities allows traders to guard their losses by leveraging price swings strategically.

You can open a commodity trading online account with a SEBI-recognised brokerage firm in India. You only need to fill an online form and submit the necessary KYC documents – PAN, ID, Address proof documents, and your income proof documents. You also need to submit your DEMAT account details so that the broker can link your commodity trading account to the DEMAT account. Linking the two accounts enables the broker to debit or credit your derivatives. Once you provide these details, you can pay the account activation fee, and the broker opens your account. You will receive your Trading ID and password, and you can begin commodity trading.

The different types of commodity trading products in India primarily comprise the following categories:

• Agricultural commodities like pulses, rice, cotton, rubber, legumes, etc.

• Metallic commodities and industrial metals like gold and silver coins, bullion, bars, aluminium, lead, copper, etc.

• Energy resources like coal, crude oil, natural gas, etc.

Commodity traders in India are primarily categorised into two types – speculators and hedgers. Speculators, also known as intra-day traders, typically try to exit their long or short positions on the same trading day or after a few days. These traders are known to be direction-agnostic, i.e., they leverage their trades as per market momentum by relying on technical charts to base their trades. On the other hand, hedgers take an offsetting or contrary position in their investments to balance their gains and losses from an underlying asset. They take on an opposite position that allows them to protect themselves against price movements and cover all their bases to ensure they take the minimum risk on their investments.

In India, commodity trading takes place on six exchanges, namely:

• Multi Commodity Exchange (MCX)

• National Multi Commodity Exchange (NMCE)

• Indian Commodity Exchange (ICEX)

• National Commodity and Derivatives Exchange (NCDEX)

• The Universal Commodity Exchange (UCX)

• Ace Derivatives Exchange (ACE)

The commodity market timings depend on the type of commodity being traded. You can trade in agricultural commodities from IST 9:00 AM to 5:00 PM from Monday to Friday. The trade timings for non-agricultural commodities is IST 10:00 AM to 11:30 PM during summers and IST 10:00 AM to 11:55 PM during winters from Monday to Friday.

Yes, commodity trading is classified as derivatives trading. Per SEBI guidelines, if you wish to conduct derivatives trading, you must submit your income proof documents. The list of valid income proof documents include

• A copy of your Bank Account Statement for the last 3 months

• A copy of your DEMAT account holding statement

• A copy of Form 16

• Latest Salary Slip

• Copy of duly filed Tax Returns

• Net Worth Certificate

• Copy of Annual Accounts.

Up until Sep 2015, Forward Market Commission (FMC) was the commodity market regulator in India. This commission was governed by the Ministry of Consumer Affairs. However, since Sep 2015, the Securities and Exchange Board of India has become the sole commodity market regulator in the country ensuring fair trading. The Commodity Derivatives Market Regulation Department (CDMRD) is appointed to carry out the daily operations under SEBI's rules and guidelines.

Commodity trading happens in dedicated exchanges created for this purpose. Some of the prominent ones in India include:

• The National Commodity & Derivatives Exchange Limited (NCDEX) - for agricultural pulses, products such as grains (flour, barley, maize, paddy), seeds, soybean, oil, cotton, spices (sugar, black and white pepper, cumin, turmeric, coriander, anise, cardamom, cinnamon) etc.

• The Multi Commodity Exchange of India Limited (MCX) - for billions of precious metals like gold or silver coins, guineas, bars, base metals such as aluminium, lead, zinc, nickel, energy sources like crude oil, natural gas, agricultural items such as rubber, palm oil, cotton, exotic spices, etc.

• The Indian Commodity Exchange Limited (ICEX) - for most of the agricultural products as listed above, fiber and jute, and diamonds and steel as well.

Settlement in commodity trading involves tallying raised and pending buy and sell instructions, and subsequently transferring the ownership of said commodities from the seller to the buyer in lieu of the funds exchanged. The commodity trading settlement process includes the following steps:

• The relevant trade details are sent to the clearing corporations by the applicable commodity exchanges

• Thereafter, the clearing corporation informs the buyers and sellers regarding their obligations and pay-in advice on funds

• The underlying clearing banks are sent a communication to ensure that they make funds available by the pay-in time

• The clearing banks debit the account of the clearing member and credit the same amount to the account of the clearing corporation to complete the pay-in of funds for executed trades

• In the case of pay-out of funds, the clearing bank credits the account of clearing member upon the instructions of the clearing corporation

Yes, SEBI has made mandatory for taking or giving delivery of commodities upon the completion of the trade.

There are three types of delivery mechanisms that are prevalent in the commodity market. These are compulsory delivery, sellers’ option, and intention matching.

In compulsory delivery, all open positions, upon expiry of contracts, need to be settled physically.

In the sellers’ option, sellers will have an edge while selecting the delivery location and quantity.

In intention matching, physical delivery of commodities happens only when both buyer and seller agree to exchange the physical commodity.

Traders are advised to check and understand the applicable delivery mechanism before going ahead with the trade.