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Introduction to Commodity Markets

Commodity market facilitates an exchange of physical goods among residents in a country. Individuals
aiming to diversify their portfolio can undertake investments in both perishable and non-perishable
products, thereby not only mitigating the risk factor, but also providing a hedge against inflation rates
in an economy.

Types of Commodities in the market

Available for trading are categorised into the following classes, based on their inherent nature:

1. Hard commodities
 Precious metals: Gold, platinum, copper, silver, etc.
 Energy: Crude oil, Natural gas, gasoline, etc.

2. Soft commodities:
 Agriculture: Soybeans, wheat, rice, coffee, corn, salt, etc.
 Livestock and meat: Live cattle, pork, feeder cattle, etc.

As of 2025, some examples of commodities in the market that were most commonly traded in major
commodity exchanges in India included energy, metal, agriculture, carbon credits.

History and Origin of Commodity market

1. Origin in Agriculture: Commodities trading began with agriculture around 10,000 BC, as
settlements farmed crops and livestock. By 8,500 BC, an agricultural revolution spurred trade
between settlements.
2. Challenges in Early Trading: Weather, conflict, and supply-demand fluctuations disrupted
pricing. Storage needs for surplus goods led merchants to seek financing, birthing futures
agreements.
3. Early Futures Trading: The first recorded commodity futures trades occurred in 17th-century
Japan, with possible rice trading in China 6,000 years ago, per commodity expert Bruce
Babcock (2009).
4. U.S. Commodities Market: In the early 1800s, U.S. Midwest grains were stored in Chicago for
eastern shipment. Perishable goods’ quality decline and price volatility led to forward
contracts, fixing future prices before delivery.
5. Chicago Board of Trade (CBOT): Established in 1848, CBOT standardized futures contracts,
specifying asset quality, delivery time, and terms, streamlining trade compared to customized
contracts.
6. Evolution of Traded Commodities:
o Agricultural products dominated futures for over a century, with soybeans added in
1936, cotton and lard in the 1940s, and livestock in the 1950s.
o Precious metals (e.g., silver) began trading in the 1960s.
o Financial futures emerged in the 1970s with currency fluctuations post-gold standard,
followed by stock indices (e.g., S&P 500) and government debt instruments in the
1980s-90s.
7. Shift to Cash Settlements: By the late 20th century, futures trading evolved from physical
delivery to cash settlements, enabling price-based trading without goods exchange.
8. Regional Expansion: By the 20th century, U.S. exchanges opened in cities like New York,
Milwaukee, and Minneapolis, but Chicago remained the dominant hub.

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 9. Online Trading Boom: Early 21st-century online platforms increased access to commodities
and futures trading, attracting new participants via electronic systems and brokerages.
10. Modern Market Dynamics: New traders, including speculators, focus on price movements for
profit rather than securing goods. This influx of third-party investors, hedging against losses
in stocks and bonds, significantly influences commodity prices.

Prices Determined in Commodities Exchange

 The prices of commodity markets are heavily dependent on the market demand and supply
of commodities, both domestically and from foreign sources.
 Speculative news also affects the commodity prices heavily, as socio-economic conditions
deeply influence the productive capacity of respective companies.

The factors affecting commodity prices in an economy are discussed below:

1. Market demand and supply Market demand and consequent supply of goods traded on a
commodity exchange heavily influence the market price. A rising demand (for any reason) can
cause prices to rise in the short run, as supply cannot be increased immediately to compensate
for the higher demand in the market.

2. Global scenario Global indicators play a crucial role in determining the prices of commodities
available internally in a country. For example, any turmoil in the Middle Eastern countries can
affect the prices at which crude oil is exported, thereby affecting the prices at which it is traded
domestically.

 A significant example can be cited in this respect when a supply shock was experienced by all
major countries in the world triggered by Iraq-Kuwait tensions in the 1990s.

3. External factors Any condition affecting the total production of stipulated goods traded in an
exchange can cause price changes accordingly. For example, a rise in the cost of production
can drive up the prices at which a product is sold in the market, consequently affecting the
equilibrium rate.

4. Speculative demand Demand for derivative investing in commodities online can arise from
speculative investors, who aim to realise profits through market price fluctuations.
Speculators often make predictions regarding the direction of movement of prices and aim to
close the contract before the expiration date to realise capital gains on total gains.

5. Market outlook Any unforeseen fluctuations in the stock market can cause investors to shift
towards commodity trade, as chances of severe fluctuations in prices of certain commodities
such as precious metals are low. Hence, commodity market investments are secure in nature
and act as a hedge against inflation for risk-averse individuals

Major Commodity Traded in derivatives exchange in India

In India, commodity derivatives trading is regulated by the Securities and Exchange Board of India
(SEBI), and there are three major commodity exchanges where traders can trade in commodity
derivatives:

Multi Commodity Exchange (MCX): MCX is the largest commodity exchange in India and offers trading
in a wide range of commodities, including precious metals like gold and silver, base metals like copper

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and zinc, energy products like crude oil and natural gas, agricultural commodities like cotton and
soybeans, and various other commodities.

National Commodity and Derivatives Exchange (NCDEX): NCDEX is the second-largest commodity
exchange in India and specializes in agricultural commodities like soybean, chana, castor seed, jeera,
and cotton.

Indian Commodity Exchange (ICEX): ICEX is a relatively new exchange that was launched in 2017 and
offers trading in diamond and various other commodities.

Some of the major commodities traded on these exchanges include gold, silver, crude oil, natural gas,
copper, zinc, lead, nickel, aluminium, cotton, soybean, chana, and castor seed, among others. These
commodities are traded in the form of futures and options contracts, and traders can use a variety of
trading strategies to manage their risk and profit from price movements in these commodities.

Types of Commodity Market:

 Spot markets are also known as “cash markets” or “physical markets” where traders
exchange physical commodities, and that too for immediate delivery.

 Derivatives markets involve two types of commodity derivatives: futures and forwards;
these derivatives contracts use the spot market as the underlying asset and give the owner
control of the same at a point in the future for a price that is agreed upon in the present.

When the contracts expire, the commodity or asset is delivered physically. The main difference
between forwards and futures is that forwards can be customized and traded over the counter,
whereas futures are traded on exchanges and are standardized.

Participants in Commodity Derivative Market

The commodity derivative market has several participants who play different roles in the trading
ecosystem. Here are the major participants in the commodity derivative market:

Hedgers: These are producers or consumers of commodities who use derivatives to manage price risks
associated with the production or consumption of commodities. For example, a farmer may use
futures contracts to lock in a price for his crop before harvest to ensure a stable revenue stream, while
a manufacturer may use futures contracts to hedge against price fluctuations in raw materials like
copper or aluminium.

Speculators: These are traders who take positions in the commodity derivative market with the
intention of making a profit from price movements. Speculators add liquidity to the market and help
discover market prices by buying and selling contracts.

Arbitrageurs: These are traders who take advantage of price discrepancies between different markets
or between futures and spot markets to make a profit. For example, an arbitrageur may buy a
commodity in a spot market and sell a futures contract for the same commodity if the futures price is
higher than the spot price.

Brokers: These are intermediaries who facilitate trades between buyers and sellers of commodity
derivatives. Brokers may also provide research and analysis to clients and help them manage their risk
exposure.

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Clearing Houses: These are organizations that guarantee the settlement of trades and manage
counterparty risks in the commodity derivative market. Clearing houses require traders to post
margins to ensure that they can fulfill their obligations if the market moves against them.

Regulators: These are government agencies that oversee the commodity derivative market and
ensure that it operates in a fair and transparent manner. In India, the Securities and Exchange Board
of India (SEBI) is the primary regulator of the commodity derivative market.

Commodity Market Indices

Commodity market indices are a type of financial benchmark that measures the performance of a
group of commodities over time. These indices are designed to reflect the price movements of a
basket of commodities and provide a snapshot of the overall health of the commodity markets.

In India, the two major commodity market indices are:

MCX iComdex: MCX iComdex is a composite commodity futures price index that tracks the price
movements of a basket of commodities traded on the Multi Commodity Exchange (MCX). The MCX
iCOMDEX series includes a composite index with 11 commodity futures across various segments.

Additionally, it comprises three sectoral indices (Bullion, Base Metals, and Energy) and nine single-
commodity indices (Gold, Silver, Aluminum, Copper, Lead, Zinc, Nickel, Crude Oil, and Natural Gas).

NCDEX AGRIDEX: NCDEX AGRIDEX is a price index that tracks the performance of agricultural
commodities traded on the National Commodity and Derivatives Exchange (NCDEX). The index
comprises 10 agricultural commodities, including soybean, chana, coriander, cottonseed oilcake, guar
gum, guar seed, mustard seed, refined soy oil, castor seed, and jeera.

Commodity market indices provide investors with a useful tool for tracking the performance of the
commodity markets and making informed investment decisions. Investors can use these indices to
compare the performance of different commodities, track long-term trends, and identify potential
investment opportunities.

Additionally, commodity market indices can be used to create index-based investment products like
exchange-traded funds (ETFs) and mutual funds that provide exposure to the commodity markets.

Commodity Futures
Commodity futures are contracts that obligate the buyer to purchase a specific quantity of a
commodity at a predetermined price and date in the future. The seller, in turn, is obligated to sell the
commodity to the buyer at the agreed-upon price and date. Commodity futures are traded on
exchanges, and their prices are determined by supply and demand factors in the market.

Commodity futures contracts are typically used for hedging or speculative purposes. Hedgers are
producers or consumers of commodities who use futures contracts to manage their price risks. For
example, a farmer may sell futures contracts for his crop to lock in a price before harvest, while a
manufacturer may buy futures contracts to hedge against price fluctuations in raw materials like
copper or aluminium.

Speculators, on the other hand, take positions in the futures market with the intention of profiting
from price movements. Speculators may buy futures contracts if they believe that prices will rise, or
sell futures contracts if they believe that prices will fall.

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Commodity futures contracts are standardized in terms of contract size, delivery date, and quality
specifications. The exchanges also specify the delivery locations and procedures for settling futures
contracts. Most futures contracts are settled in cash, but some contracts may involve physical delivery
of the commodity.

In India, commodity futures trading is regulated by the Securities and Exchange Board of India (SEBI),
and there are three major commodity exchanges where traders can trade in commodity futures: the
Multi Commodity Exchange (MCX), the National Commodity and Derivatives Exchange (NCDEX), and
the Indian Commodity Exchange (ICEX).

Commodity Options

Commodity trade options contracts are rights to buy (call option) or sell (put option) underlying
commodity futures at predetermined prices on the date of contract expiry. It is important to note
that, unlike in equity options where options involve rights to sell or buy shares of companies at pre-
set prices, it works a bit differently for the commodity trading space.

 Options trading in commodities is widespread globally with major exchanges like CME,
NYMEX, LME and ICE offering options on commodities ranging from gold to oil to industrial
metals.
 After a 13-year long gestation, Indian commodity markets launched options in Gold, opening
new avenues for trading and hedging.
 However, it is important for traders/speculators and investors to understand options trading
in commodity markets as the expiry process is different from that of equities and Forex.

Broadly, there are two types of commodity options, a call option and a put option, similar to what
we have in equities and Forex. There are two sides to every option trade, a buyer and a seller. Each
of these sides experiences the opposite outcome; if the option buyer is making money the option
seller is losing money in the identical increment, and vice versa.

Gold options: A refiner/ Jeweller can sell out of the money options against their inventory, if they
are willing to accept considerable amounts of risk with the prospects of limited reward, can write (or
sell) options, collecting the premium. The premiums might be small on an absolute basis but your
inventory can pay you returns and generate additional income. On the other hand, an option buyer
is exposed to limited risk and unlimited profit potential, but faces inherent risk like with any form of
speculation.

Example: Suppose a jeweller holds 100 ounces of gold in inventory, and the current market price of
gold is $2,000 per ounce. The jeweller wants to generate extra income from this inventory using
options, while a speculative trader considers buying options.

Strategy 1: Jeweller Sells Out-of-the-Money Call Options

The jeweller decides to write (sell) 100 out-of-the-money call options on their 100 ounces of gold:
 Strike Price: $2,200 (above the current $2,000 price, so it’s OTM).
 Expiration: 3 months.
 Premium: The jeweller collects $10 per ounce as the premium, earning $1,000 total (100
ounces × $10).

 If gold stays below $2,200 (e.g., $2,100 at expiration):

o The options expire worthless, and the jeweller keeps the $1,000 premium as profit.

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 o The jeweller still holds the 100 ounces of gold, which can be sold or used later.
o Reward: Limited to the $1,000 premium.

 If gold rises above $2,200 (e.g., $2,300):

o The option buyer exercises the option, forcing the jeweller to sell their 100 ounces at
$2,200.
o The jeweller delivers the gold from inventory, missing out on the extra $100 per ounce
($2,300 - $2,200 = $100 × 100 ounces = $10,000 potential profit).
o The jeweller still keeps the $1,000 premium, but the loss of potential profit is
significant.
o Risk: Considerable, as gold prices could soar (e.g., to $3,000), forcing the jeweller to
sell at $2,200, losing $800 per ounce ($3,000 - $2,200).

Advantages:
 Cost is lesser than taking a futures contract, returns are relatively higher and maximum loss
is limited to the premium or price of option, unlike in futures where returns are high and
losses can be unlimited.
 There is no mark to market margin calls for option buyers since they pay premium upfront to
the option seller.
 Options are also more flexible and an option holder can participate fully in any price
movement
 Options represent a form of price insurance, the cost of which is the option premium
determined.

Uses of Commodity derivatives: Hedging, Speculations, and Arbitrage

Commodity derivatives have several uses, including hedging, speculation, and arbitrage. Here’s a brief
overview of each:
Hedging: Hedging is a risk management strategy used by producers and consumers of commodities to
protect themselves from price fluctuations. For example, a farmer may sell a futures contract for his
crop to lock in a price before harvest, ensuring that he will receive a stable revenue stream even if
market prices decline. Similarly, a manufacturer may buy a futures contract to hedge against price
fluctuations in raw materials like copper or aluminium.

Speculation: Speculation is the act of taking positions in the commodity derivatives market with the
intention of profiting from price movements. Speculators add liquidity to the market and help discover
market prices by buying and selling contracts. For example, a speculator may buy a futures contract
for crude oil if he believes that prices will rise, and sell the contract at a profit if prices indeed increase.

Arbitrage: Arbitrage is a strategy that takes advantage of price discrepancies between different
markets or between futures and spot markets to make a profit. For example, an arbitrageur may buy
a commodity in a spot market and sell a futures contract for the same commodity if the futures price
is higher than the spot price. By doing so, the arbitrageur locks in a profit by buying low and selling
high.

Overall, the commodity derivatives market provides a range of tools for managing risk and creating
investment opportunities for market participants. By providing a mechanism for buyers and sellers to
manage price risks associated with the production and consumption of commodities, commodity
derivatives help ensure the stability of the global economy.

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