Invest in commodity futures to diversify portfolio

To begin the process,one must approach any member of the commodity exchange to register as a client (a list of registered members is given on the exchange website). Then,fill up the know-your-customer form and provide required documents to open a client trading account. Members charge a nominal amount for this. A unique client code is allotted to you for trading in commodity futures. You have two options: online or offline trading facility,pick any one as per your convenience. Now,the ground is prepared to start your first innings.

There is a long list of commodities that are offered for futures trade,but remember that you choose those which are known to you. In other words,pick the ones where you have a sound basis to make price conjectures for a commodity. Read product notes,understand the product you want to trade in and be conversant with contract specifications. When you are dealing with commodities only for investment purpose (ie,you are not dealing in physical delivery),then there is no need to open a demat account (in addition to the trading account).

In case you have a strong price view in either direction for a commodity,you can take a position in the futures market,that is,either go long (buy) or go short (sell). Here,we pick pepper for an illustration. Say the near-month futures (the current month or the month closest to the current month) contract for pepper is trading at R28,000 per quintal and one trading lot for the black spice is one metric tonne.

Now,let’s look at the expenditure sheet for carrying out a transaction in commodity futures. It will cost you R280,000 to buy one tonne of pepper. But an investor need not pay this full amount for buying commodity futures; it’s only the margin that is paid upfront by the participant. The margin on this contract is around 7%. That means R19,600 is required to be paid upfront as margin money.

In order to settle daily mark-to-market (MTM) obligations,an additional amount will be required if prices move in the opposite direction (if you have a long position and the price moves down). Therefore,some additional fee for meeting MTM requirements is also charged by the member. For this,you (as a client) will have to provide funds either on a day-to-day basis or deposit some funds beforehand with the member (your broker).

Other charges that will be paid by an individual include exchange transaction fees,brokerage charges,service tax (10.36%) and stamp duty as applicable in different states (R100 per crore in Delhi). All these charges will generally not be more than R30 per lakh. That means for a transaction value of R2.5 lakh,it will not be more than R75. However,these charges will also be applicable when you square off your position.

In case you had taken a long position with a positive call for the prices and the price of pepper futures moves up to R29,000 per quintal,you square off by taking an opposite position. Then you make a profit of R10,000 on one tonne of pepper transacted. From this R10,000,you have to deduct the charges paid (excluding margin) to arrive at your net profit.

Margin money is released on squaring off the position and profit is credited to the members account on T+1 day which she then passes on to the client. If you have a long-term price view,you can roll over the position before the near-month contract expires to the mid-month or far-month futures contract.

* The writer is economist,NCDEX Institute of Commodity Markets & Research