MCX Gold futures: An opportunity for price risk management

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1 MCX Gold futures: An opportunity for price risk management Shaivalya Thaker Manager-Training 25 August,2005

2 Introduction MCX Gold futures contracts Features Performance Opportunity for price risk management Strategies using futures Implications

3 Introduction

4 Meaning Commodity futures Benefits Pricing Meaning of Basis Contango (Normal market) Backwardation (Inverted market) Meaning of Spread Intra commodity Inter commodity

5 MCX Gold Futures contracts

6 Gold futures contracts at MCX Gold Price Quote: Rs./10 gms. Trading unit/lot Size: 1 kg Maximum Order: 10 kg. Current contracts available for Trading at MCX Gold OCT 2005 ( Expiry date- 5 th Oct 2005) Gold DEC 2005 ( Expiry date- 5 th Dec 2005) Order Type 1 Lot: 100: 1kg 2 Lot: 200: 2kg 3 Lot: 300: 3kg Example: Price Quote:Rs.6000/10gms Margin:3.5% Margin:Rs.21000/-

7 Contract details MCX Gold October 2005 futures contract Price Quote : Ex-Ahmedabad Margin : 3.5% Daily price limit : 2.5% Delivery lot : 1 Kg. Delivery center : Ahmedabad/Mumbai Delivery type : Compulsory Delivery standards : as per the contract specification Tender & Delivery period : 1 st October, 2005 to 6 th October,2005 Approved warehouse/vault : Group 4 at Ahmedabad/Mumbai

8 Silver futures contracts at MCX Silver Current contracts available for Trading at MCX Price Quote: Rs./1 Kg. Trading unit/lot Size: 30 Kg. Maximum Order: 600 Kg. Silver SEP 2005 ( Expiry date- 5 th Sep 2005) Silver DEC 2005 ( Expiry date- 5 th Dec 2005) Order Type 1 Lot: 30: 30kg 2 Lot: 60: 60kg 3 Lot: 90: 90kg Example: Price Quote:Rs.10500/1Kg Margin:5% Margin:Rs.15750/-

9 Features

10 MCX Gold futures contracts Concurrent contracts Different types of contracts Longer trading hours T+1 settlement Delivery based settlement Multiple delivery center Deliverable gold bars of approved suppliers

11 Performance

12 MCX Gold futures contracts High volume High open interest Low impact cost High positive correlation with International prices

13 Volume

14 Open interest

15 MCX Gold futures price curve

16 Opportunity for price risk management

17 Long hedge MEANING : Buying a futures contract to hedge physical position PARTICIPANTS : Dealers/Fabricators/Jewellers OBJECTIVES : To protect increase in the cost of raw material. To replace inventory value at a lower prevailing cost. To protect uncovered sale of finished products.

18 Price fix hedge-an illustration Date Spot price Gold AUG JUN Date Spot price Gold AUG JUN Market Date Nature of tran. Market Price Date Nature of tran. Market Price Spot 11-Jun Jun-05 BUY 6230 Profit/ (loss) Futures 21-Jun-05 BUY Jun-05 SELL Net purchase price 6102

19 Long hedge

20 Short hedge MEANING : Selling a futures contract to hedge physical position PARTICIPANTS : Dealers/Fabricators/Jewellers OBJECTIVES : To protect the price of finished product. To protect price of inventory not covered by sale. To protect price for estimated production of finished product.

21 Offset hedge-an illustration Date Spot price Gold AUG JUL Date Spot price Gold AUG JUL Market Date Nature of tran. Market Price Date Nature of tran. Market Price Profit/ (loss) Spot 11-Jul-05 BUY Jul-05 SELL Futures 11-Jul-05 SELL Jul-05 BUY NET 20

22 Short hedge

23 Rolling over the hedge position Hedging horizon longer than available futures contracts Rolling over before enters into delivery period Liquidity risk Basis risk

24 Roll over

25 Strategies using futures

26 Investment/Trading MEANING : Buying a futures contract /Selling a futures contract PARTICIPANTS : Investors/Traders OBJECTIVE : To earn from expected increase / decrease in the futures price based on fundamental / technical analysis.

27 Spread MEANING : Buying a near month futures contract and selling a far month futures contract / Selling a near month futures contract and buying a far month futures contract PARTICIPANTS : Investors/Traders OBJECTIVE : To earn from existing spread between near month futures contract and far month futures contract.

28 MCX prices

29 Arbitrage MEANING : Cash and carry arbitrage means buying physical asset with borrowed funds and simultaneously selling the futures contract which is closed by delivering physical asset on maturity of the futures contract. Reverse cash and carry arbitrage means lending funds realized by selling physical asset and simultaneously buying the futures contract which is closed by taking delivery of physical asset on maturity of the futures contract. PARTICIPANTS : Arbitragers/Financers OBJECTIVE : To earn from the existing difference between spot and futures prices.

30 Arbitrage Cash & carry arbitrage opportunity when F (o, n) > S(o) (1+c) Reverse cash & carry arbitrage opportunity when F (o, n) < S(o) (1+c)

31 Implications

32 Implications Hedging Hedging reduces or limits the price risk associated with the physical asset Outright position Outright position is risky as it is a leveraged transaction. Spread trading Spread trading is an yield improvement strategy which is less risky than outright position & payoff does not directly depend on the direction of the price movement. Arbitrage Arbitrage transaction results in minimum profit potential subject to execution risk.

33 Thank You

34

35

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