CONCEPT – FUTURES AND OPTIONS MARKET FOR INDIAN FARMERS

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 CONCEPT – FUTURES AND OPTIONS MARKET FOR INDIAN FARMERS

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• Problem with agriculture: The time gap between initial investment (sowing of crops) and the final returns (harvesting and sales) is large. Hence, farmers are vulnerable to price fluctuations because the time gap is too large between sowing and final sale.
• Problem with buyers: The purchasers of agricultural commodities (for use as inputs in production) decide at different times of the year. They can be exposed to the same pricing fluctations.
• A solution exists: Under normal market conditions, nothing will change. But if "forward contracts" are used, a solution exists.

1. Sellers and buyers can enter into 'forward contracts'. 
2. These contracts specify the quantity, quality and price of the commodity to be delivered for sale (or acquired for purchase) at a pre-decided date in the future.
3. This guards against price volatility and uncertainty in availability.

• What are ‘Future contracts’: These are contracts to buy or sell a quantity of a standard quality of a commodity. 

1. These can be traded in exchanges, through brokers, with no need for the buyer and seller to meet and negotiate. 
2. A contract need not be settled by actual delivery but can be matched by an offsetting contract taken by the buyer or seller, and the two can be squared at any point at some gain or loss.

• "Options": To avoid paying margins, traders can buy an "option" to offer (sell) or acquire a contract (buy) at some specified future date. If the option is not exercised (price movements contrary to expectation) the loss is restricted to the premium paid to hold the option and the transaction costs of acquiring it.
• Futures Market: Futures trading can help improve agricultural production system. 

1. The Futures markets enable farmers to deliver the crop at a specified price at some future date. 
2. The clearing houses of the commodity exchanges guarantee the performance of these contracts. 
3. A farmer, who is uncertain about the prices of his produce, can cover his risk by selling a futures contract sometime before the harvest day.
4. The futures prices are available for all farmers on a continuous basis.
5. If the price available in the futures market is not profitable to the farmer, he can change his cropping plan at the beginning of production itself.
6. The futures market provides perfect collateral for the lenders to advance larger loans on easier terms to the farmers thereby ensuring a minimum-risk business for both the lender and the farmer.
7. Futures market provides a convenient mechanism through which a farmer who wants to speculate on commodity but does not have the storage capacity can increase his speculative ability. 

• Buy and Sell: Farmers can ‘buy a position’ while the crop is growing - by buying a futures contract. At the time of harvesting, a farmer can sell his crop in the cash market simultaneously squaring off his ‘position in the futures market. This way he can gain from any price increase in both the spot as well as the futures market at the time of harvesting.
• History in India: Indian commodity futures have had a long and chequered history. Until 2003, the futures contract was being traded only at regional exchanges that specialised in one or a few commodities. In 2003, the government mandated the setting up of nation-wide online commodity exchanges and allowed futures in a wide gamut of commodities.

1. There are four national level commodity exchanges - (a) the Multi Commodity Exchange (MCX), (b) National Commodities and Derivatives Exchange of India (NCDEX), (c) National Multi Commodity Exchange (NMCE) and (d) the National Board of Trade (NBOT). 
2. The first three exchanges trade in all the permitted commodities, while NBOT trades only in soyabean. 
3. Regulator for these is the Forwards Markets Commission (FMC).

• Parallels with share market: It has a spot segment and a F&O segment.

1. Spot segment - This is the cash market where shares are bought and sold
2. F&O segment - Futures and options on shares and indices can be bought and sold
3. Futures contract - You can buy or sell an underlying stock or index at pre-decided price, for delivery on future date
4. Options contract - An option is a contract which gives the buyer the right (but not the obligation) to buy or sell an underlying asset or instrument at a specified strike price prior to or on a specified date, depending on the form of the option. They are either CALL or PUT.
5. Options contract - CALL - The buyer has the right to buy an underlying stock at a present price throughout the duration of the contract. The call seller will be obliged to give delivery even if present market price is higher.
6. Options contract - PUT - The buyer has the right to sell an underlying stock at a present price throughout the duration of the contract. The put seller will be obliged to buy from the put buyer even if the market price is lower.
7. Both the Call and Put sellers receive premia from the buyers.

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