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There are two Indian commodity exchanges: Multi Commodity Exchange, (MCX), and National Commodity and Derivative Exchange, (NCDEX). MCX is most popular for Metals and Energy commodities, while NCDEX is for all agri commodities. There is also a lot of activity in MCX for agri commodity. In the following chapters, I will be discussing these commodities traded on exchanges as well as familiarizing you with commodity contracts.
We will examine every commodity traded on the commodity swaps. It is important to understand the contract specification and to identify the factors that influence the commodity. I'll skip the background section on the commodities market, which covers the history, forwards markets and farmers in the US. This information is found in nearly all materials on the Commodity Market. Let me get to the core of the matter by cutting and dicing commodity contract specifications and any other details.
Here's the list of commodities that MCX allows you to trade. I obtained this list via the MCX website.
It is important to include all major commodities that can be traded. It is important to be familiar with how "Derivative Futures" work before you attempt to understand Commodities. If you don't know much about Futures, I encourage you to review the module onfuture trade.
However, assuming you're familiar with Futures, let us now begin with Gold.
Gold is a highly traded contract on MCX. It is a highly liquid commodity, with daily trades of approximately 15,000 contracts translating into a Rupee value exceeding 4500 Crore. These numbers are for one type of Gold contract. It is often called "Big Gold".
There are many options for gold that you can trade-in. These contracts can be confusing for both novice and experienced commodity traders. They are not easy to understand and trade. Let me start by listing all the types of Gold contracts.
All of these variations belong to the same underlying, which is Gold. All these variants belong to the same underlying, i.e. Gold. Understanding the contract specifications of each variant is the best way to learn the differences. We'll start with the big guy first. "The Gold"
Here's the contract specification according to MCX. Let me first list the most important and then we will get to know them all.
| Particular | Value |
|---|---|
| Price Quotation | Rupee for 10 grams, including all taxes and levies related to import duty |
| Lot Size | 1 kilogram |
| Tick Size | 1 rupee |
| P&L per tick | Rs. 100 |
| Expiry Date | 5 The day of your contract month |
| Delivery logic | Compulsory |
| Delivery Unit | 1 kilogram |
These details will be discussed in the same order as the contracts so it is easy to understand them. Let's start with the price quote.
As you can see, the price quoted is for 10 grams of gold. The price quoted includes all import duties and taxes. We will discuss this later. The price of MCX does not include import duties and taxes. The following snapshot shows you the most recent traded price for gold futures on MCX.
As you can see, Gold's last traded price was Rs.31.331/-. This is the price for 10 grams gold. We can calculate the contract value since the lot size is 1 Kg (1 1000 Grams).
(1000 * 331331) / 10.
= Rs.31.33.100/-
What is the minimum margin needed to trade this? This can be checked using Zerodha's Margin Calculator -
The margin amount is Rs.1,258,868/-. This means that the margin percentage is approximately -
1,25,868/ 31,33,100
=4.017%
The margin percentage is about 4%. This is very similar to currency contracts. The Rupee value for the margin is too high and prevents many retail traders from launching positions in Gold. This is why we have contracts such as Gold Mini and Gold Petal where the Rupee values of the margins are lower. These contracts will be discussed in detail later.
Let's say you purchase 1 lot of Gold on MCX. This means that you need to have close to 1.25 Lakhs of margin. With each tick, either you make Rs.100, or you lose Rs.100. How did this happen? It is quite simple.
P&L per tick = (Lot Size / Quotation) * Tick Size
Let's apply this to Gold
= (1000 Grams/10 Grams) * 1 Rupee
100 Rupees
This formula can be applied to any futures or options contract to calculate the P&L for each tick. This formula will be applied to the JPY-INR contract. You will recall that the contract was 100000 JPY in lot, the quote was 100 JPY and the tick size was 0.0025. This allows us to calculate the P&L per tick.
(100000/100).*0.0025
2.5 Rupees
Let's now concentrate on expiry. The expiry of Gold is simply 5 the day after the contract month. Every 2 months Gold contracts are created. Each contract remains in the system for one year. You will always have 6 options to choose from. The following table, which was created in August 2016, should give an overview of how it works.
| Contracts currently available | Expires: |
|---|---|
| October 2016, | 5 th October 2016 |
| December 2016, | 5th Dec 2016 |
| February 2017, | 5 February 2017 |
| April 2017, | 5th April 2017 |
| June 2017 | 5th Jun 2017 |
| August 2017, | 5 th August 2017 |
It is obvious that the most liquid contract to trade is the latest contract. In this instance, it would be the October 2016 contract. The October 2016 contract expires in October 2016. September 2017 will be introduced. The December 2016 contract would be the most active contract starting on Oct 5, 2016.
Remember that settlements in equity are always made in cash, not in physical form. But, commodities are physical so 'delivery is mandatory'. If you have 10 tons of gold and choose delivery, you will receive 10 kg. You must express your intention to receive the commodity. You must do this before the commodity expires on 4 days. Given that expiry is on the 5th, it is important to indicate your intent to take delivery on or before the 4th (either the 2nd, 3rd, or 4th).
Zerodha does not permit you to enter the physical delivery of commodities if you trade with them. You will have to close your position by the end of the expiry month 1 st. Personally, I prefer to close positions as soon as possible and not get involved in the physical delivery of commodities.
Practically speaking, these are the essential facts about the Gold contract.
Now we will move on to the other varieties of gold traded on the exchange
As you can see, the big gold contract requires a high margin requirement in terms Rupee value. This makes it difficult for traders to trade the big gold contract. Perhaps this is why the exchanges have introduced contracts that require a lower margin requirement.
Other gold contracts are also available for trade: -
These are the details for other gold contracts:
| Get a Price Quote | Lot Size | Tick Size | P&L/tick | Expiry | Delivery logic | Delivery Unit | |
|---|---|---|---|---|---|---|---|
| Miniature Gold | Rs. per 10 gm | 100 gm | 01 rupee | Rs.10 | 5 The Day | Compulsory | 100 gm |
| Gold Guinea | Rs. per 08 gm | 08 gm | 01 Rupee | Rs.01 | Last day | Compulsory | 08 gm |
| Gold Petal | Rs. per 01 gm | 1 gm | 01 Rupee | Rs. 01 | Last day | Compulsory | 08 gm |
Given that we've already discussed these details, I think the table is much easier to understand. Let's get to the margin details.
As you can see, the margin required for Gold Mini (GoldM), contract is Rs.15.682/-. Percentage -
= Margin / Contract Value
Contract Value = (Price * Lots Size)/Price Quotation
= (31365 * 100)./10
Rs.313,650
=15682/313650
=5%
This is about the same margin percentage as large Gold. Let's quickly calculate the P&L per tick of Gold Mini. We know:
P&L per tick = (Lot Size / Quotation) * Tick Size
= (100/10),*1
= Rs.10/- per tick.
We also have the Gold Mini and Gold Petal contracts. These contracts are very small and require a narrow margin. They can be as low as Rs.1251 for Gold Guinea or Rs.154 for Gold Petal. Because the lot size is small, so is the contract value. There are a few variations, such as Gold Petal (Delhi), Gold Guinea, (Ahmadabad), etc. that you will see. I suggest that you ignore them, especially if you plan to trade Gold.
My honest opinion is that if you trade Gold, stick to the Big Gold or Gold Mini contracts. The liquidity in all other contracts is very poor. Here is a look at liquidity during a normal trading day (on the MCX).
You shouldn't be tempted to believe that Gold Petal has high liquidity. However, the Gold Petal lot size of 8 grams is 8 grams. Therefore, 8-9K lots equals roughly 2-2.5 Crs.
Important note: liquidity is at its highest in next month's contract. So make sure you stick with these. Here's a rule of thumb: the closer the contract expires, the lower the liquidity.
This assumes you are familiar with logistics and the Gold contracts. We will be discussing a number of interesting topics in the next chapter. These include the parity between domestic and international gold contracts, factors that influence Gold, the relationship among gold, equities, and the dollar, as well as other important topics like the role of gold and the relationship with equities and the dollar.