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Trading in commodities

An investor can choose from several investment and trading strategies, depending on the risk appetite, writes Jayant Manglik.

india Updated: Nov 28, 2007 22:22 IST
Jayant Manglik
Jayant Manglik

Commodity futures markets are a free market tool which will perform a much-needed economic function in that direction by helping agriculturists plan their crop patterns as well as get the best available prices across the country, with transparency. Similarly, producers, processors and industrial consumers of metals, bullion and energy products can use the market effectively to hedge positions and transfer or spread the risk.

However, there are several winning investment and trading strategies for investors to choose from the commodity markets, depending on their risk appetite. Some of these are as follows:

Spot–futures arbitrage

It is the favourite product because it has one of the finest risk-reward ratios. It basically has two legs. In the first, your broker buys a commodity for you from the 'Mandi' or spot market and simultaneously executes the second leg by selling the same commodity, in the same quantity, in the futures exchange at a higher price, locking in the profit.

For example, if there is a difference in price between spot and futures markets, say at Rs 1,500 and Rs 1,800 for near/next month futures respectively, one can buy in the spot and sell in the futures markets fetching an assured return of Rs 300. The returns work out best for agricultural commodities. The risk may arise only on quality issues of the material purchased.

Spread trading

A much used trading strategy, including in equity markets, it involves taking a position in one calendar month and a reverse position in the following contract aiming to make money from the variation in the difference between the two contracts. In general, one would buy a near month contract and sell the far month contract and reverse positions when the difference reduces and vice-versa. There is a higher element of risk here, because both positions can go wrong. But it is a preferred strategy for experienced traders.

Inter-exchange arbitrage

For the sharp-eyed, these opportunities already exist and are exploited. You can be sure that more of this opportunity will be thrown up soon with NCDEX shifting focus to metals as well. Price anomalies between MCX and NCDEX can be harvested keeping in mind the different settlement schedules as well as dissimilar product specifications.

International arbitrage

This was probably one of the best ways to profit from market price inefficiencies and make money from the difference in prices of, say, copper on the MCX and on COMEX. Today, this facility is only available to larger companies with trading facilities abroad.

Info for first-timers

If you are a first time trader, one strategy to consider is to track only one or two commodities and understand the factors affecting them, rather than all the listed commodities. The markets are very dynamic and react to a variety of news from different sources - both fundamental and technical. The job of a prudent trader is to sift through what information is important and what is not (ie what the market has already considered and what is news to the market).

(The author is the Head, Commodities, Religare)

First Published: Nov 28, 2007 22:19 IST