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Commodity Trading : Different types of derivatives

Commodity Trading: Different Types of Derivatives

Trading in the commodity market involves buying or selling commodities on exchanges such as the MCX and derivative trading is a part of this market. Here, derivatives are products, which get their value from an underlying asset or other variables. Trading in derivatives can be of two types - exchange trading or over the counter. The latter is applicable to most complex types of derivatives and transactions are conducted directly between large financial institutions.

The commodity derivatives market covers various segments such as agriculture, metals, coal, crude oil, and gas to name a few. Benefits of derivatives are that they boost entrepreneurial activity, increase long-term returns and savings, and help transfer risk from conservative traders to risk takers. The different types of derivative instruments in commodity trading are:

  • Forwards
  • These are contracts between a buyer and a seller to purchase or sell something on a later date at a price agreed upon the current date. Also known as forward commitments, they do not come with a cancellation clause

  • Futures
  • A futures contract is defined as a financial agreement between two parties (buyer and seller)to buy or sell an asset at a future date. Futures contracts are subject to daily settlements. They have quite a few things in common with forwards contracts from which they have evolved.

  • Options
  • Options can be categorized into two categories - call and put. In a call, the buyer has the right to buy a certain quantity of the underlying asset at a determined price on or before a particular date. Similarly, put gives the buyer the right to sell a certain quantity of the underlying asset at a determined price on or before a particular date. There is no obligation involved in either.

  • Swaps
  • This refers to an exchange of financial instruments between two parties as per an agreed upon formula. They help to hedge risks of different kinds. Currency and interest rate swaps are commonly traded in the market 

    The Securities and Exchanges Board of India (SEBI), has quite a few measures in place to safeguard the rights of investors in the derivatives market as well as online commodity trading.