Though the history of commodities market in India dates back to 1900s the organized and regulated market commenced hardly 4 years ago with the inception of three national level exchanges Multi Commodity Exchange (MCX), National Commodities Derivatives Exchange, and National Multi Commodity Exchange (NMCE).
The chief economic justification for the creation of a regulated commodities futures and options market is to enable producers to hedge the price risk that arises from their normal business operations.
Risk Management Strategies-Spot Market
While some agricultural producers do not engage in any type of hedging or marketing strategy - they simply sell their crop in the cash market upon harvest and accept the prevailing price - many producers utilize hedging strategies made available by their local grain operators. The more popular of these strategies include the forward contract, the hedge-to-arrive (HTA) contract, and the minimum price contract.
For agricultural producers who are naturally long wheat, pulses or sugar, the exchanges enable the construction of hedging strategies that reduce the uncertainty of the price received from grain sales. These commodity futures can be used to replicate many of the heding strategies offered by the spot market and more importantly, can be used to create other strategies that are more responsive to your expectations and budget.So why bother to construct hedging strategies yourself using commodity futures? Why not take the strategies offered by local grain operators granted?
The Advantages of having a own hedging strategy:
There is, of course, the old adage, 'If you want something done right, do it yourself.' There is no substitute for the satisfaction and sense of control that comes from knowing exactly what is going on. That is, knowing how the hedge works, knowing what you have to gain or lose, and knowing what to watch out for, if anything. The latter, in particular, is really the best way to avoid a financial nightmare down the road. And such a financial nightmare was realized by corn producers across several states in the United States in the summer of 1996 who relied on HTA contracts to hedge and who didn't fully understand the implications of the contract.*
Beyond this, you may have other reasons to reduce your dependency on the local elevator.
Hedging Strategies with Exchange Commodity Futures:
The wide variety of commodity futures market provides the producer with a multitude of choices, much more so than with the spot market operator. Using futures or options or combinations thereof, the producer can construct a hedge that best conforms to his or her price expectations and operating budget. For example, the HTA contract and minimum price contract can both be replicated using CBOT futures and options. These are among the simplest of hedging strategies. The hedging strategies can be further customized, for example, by varying the strike price or expiration of the component options in attempt to improve the overall performance of the hedge, all of which is again made possible because of the extensive listings of exchange contracts that are available for trading.
A chief concern and in some cases, limiting factor, when using futures and options is the operating cash that is needed while the hedge is active. In general, the outright selling of a futures contract or an option contract generates a margin requirement which must be covered by cash in the account. The premium of a purchased option must be paid for in full upfront. And cash is required to cover the day-to-day loss, if any, on the hedge position. For producers, the latter becomes an issue during periods of rising prices. While the premium of purchased options is a cost, the others are not: the act of closing the hedge position eliminates the margin requirement and the capital loss, if any, on the hedge position itself should be recouped upon selling grain in the cash market at a higher-than-expected price. Because of its importance, notional cash requirements are listed for each of the hedge strategies described at right. Some require less operating cash than others. In particular, the hedge strategy, "Zero-Cost Collar with Upside", is not capital intensive yet still provides a floor selling price while leaving open the upside.
Constructing your own hedge using exchange futures is at first a learning process. Think of the time spent as an investment in your business. The agricultural futures that trade on the exchanges will continue to be around. Once you learn these hedging techniques, you can use them for years to come, and so can your children and their children.
Managing the Futures & Option Hedge
A hedge is not put in place and then forgotten. Rather, it is dynamic. It must be managed to properly respond to changing price expectations. For example, the size of the hedge may need to be reduced or increased, or some or all of the hedge may need to be rolled to another contract month. The on-going management of a hedge using exchange futures is much easier than that with the local elevator for the following reasons:
(1) Information. The free dissemination of prices by the exchange enables calculation of the value of a futures and options hedge on an almost real-time basis.
(2) Accessibility. With regular trading in the pit and overnight electronic trading, exchange contracts can be bought and sold quickly and easily almost any time of the day, allowing the producer to instantly react to a changing market environment.
(3) Variety. The many futures and options contracts that are available for trading not only permits a variety of hedges to be constructed, but also enables flexibility in managing those hedges.
Note: The above article is furnished keeping in view the International commodities market, hence the mentioning of Options can be seen.
The chief economic justification for the creation of a regulated commodities futures and options market is to enable producers to hedge the price risk that arises from their normal business operations.
Risk Management Strategies-Spot Market
While some agricultural producers do not engage in any type of hedging or marketing strategy - they simply sell their crop in the cash market upon harvest and accept the prevailing price - many producers utilize hedging strategies made available by their local grain operators. The more popular of these strategies include the forward contract, the hedge-to-arrive (HTA) contract, and the minimum price contract.
For agricultural producers who are naturally long wheat, pulses or sugar, the exchanges enable the construction of hedging strategies that reduce the uncertainty of the price received from grain sales. These commodity futures can be used to replicate many of the heding strategies offered by the spot market and more importantly, can be used to create other strategies that are more responsive to your expectations and budget.So why bother to construct hedging strategies yourself using commodity futures? Why not take the strategies offered by local grain operators granted?
The Advantages of having a own hedging strategy:
There is, of course, the old adage, 'If you want something done right, do it yourself.' There is no substitute for the satisfaction and sense of control that comes from knowing exactly what is going on. That is, knowing how the hedge works, knowing what you have to gain or lose, and knowing what to watch out for, if anything. The latter, in particular, is really the best way to avoid a financial nightmare down the road. And such a financial nightmare was realized by corn producers across several states in the United States in the summer of 1996 who relied on HTA contracts to hedge and who didn't fully understand the implications of the contract.*
Beyond this, you may have other reasons to reduce your dependency on the local elevator.
- Perhaps you feel that their fees are too high, or that the terms of their contracts are too restrictive.
- Maybe you find disputes too hard to reconcile.
- Or it could be that you want to diversify business exposure and not conduct all of your business with the same counterparty. The exchange commodity futures eliminate this counterparty credit risk because every transaction is backed by the financial guarantee of the clearing corporation.
- When you hedge using a strategy provided by the elevator operators, they in turn often establish an offsetting hedge in the corresponding exchange. So by establishing the hedge yourself directly in the futures and options market, you're simply cutting out the middle man.
Hedging Strategies with Exchange Commodity Futures:
The wide variety of commodity futures market provides the producer with a multitude of choices, much more so than with the spot market operator. Using futures or options or combinations thereof, the producer can construct a hedge that best conforms to his or her price expectations and operating budget. For example, the HTA contract and minimum price contract can both be replicated using CBOT futures and options. These are among the simplest of hedging strategies. The hedging strategies can be further customized, for example, by varying the strike price or expiration of the component options in attempt to improve the overall performance of the hedge, all of which is again made possible because of the extensive listings of exchange contracts that are available for trading.
A chief concern and in some cases, limiting factor, when using futures and options is the operating cash that is needed while the hedge is active. In general, the outright selling of a futures contract or an option contract generates a margin requirement which must be covered by cash in the account. The premium of a purchased option must be paid for in full upfront. And cash is required to cover the day-to-day loss, if any, on the hedge position. For producers, the latter becomes an issue during periods of rising prices. While the premium of purchased options is a cost, the others are not: the act of closing the hedge position eliminates the margin requirement and the capital loss, if any, on the hedge position itself should be recouped upon selling grain in the cash market at a higher-than-expected price. Because of its importance, notional cash requirements are listed for each of the hedge strategies described at right. Some require less operating cash than others. In particular, the hedge strategy, "Zero-Cost Collar with Upside", is not capital intensive yet still provides a floor selling price while leaving open the upside.
Constructing your own hedge using exchange futures is at first a learning process. Think of the time spent as an investment in your business. The agricultural futures that trade on the exchanges will continue to be around. Once you learn these hedging techniques, you can use them for years to come, and so can your children and their children.
Managing the Futures & Option Hedge
A hedge is not put in place and then forgotten. Rather, it is dynamic. It must be managed to properly respond to changing price expectations. For example, the size of the hedge may need to be reduced or increased, or some or all of the hedge may need to be rolled to another contract month. The on-going management of a hedge using exchange futures is much easier than that with the local elevator for the following reasons:
(1) Information. The free dissemination of prices by the exchange enables calculation of the value of a futures and options hedge on an almost real-time basis.
(2) Accessibility. With regular trading in the pit and overnight electronic trading, exchange contracts can be bought and sold quickly and easily almost any time of the day, allowing the producer to instantly react to a changing market environment.
(3) Variety. The many futures and options contracts that are available for trading not only permits a variety of hedges to be constructed, but also enables flexibility in managing those hedges.
Note: The above article is furnished keeping in view the International commodities market, hence the mentioning of Options can be seen.
No comments:
Post a Comment