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Chapter 8

Commodities Trading System and Settlements

Index of Contents:

The key to any market is the actual operating system that underlies the execution and the clearing and settlement system that works silently in the background. Clearing is about the daily determination of the obligations of various parties while settlement is about ensuring that the debits and credits are given by the clearing corporation to the respective Clearing Members (CM) to be passed on to Trading Members (TMs) and onwards to the clients. The entire system works seamlessly and there is a clearing corporation which acts as the counter party / guarantor of every futures and options trade on the commodity exchange.

CONNECTIVITY, PLATFORMS AND ONLINE COMMODITY TRADING SYSTEM

Your interface with the commodity futures exchange begins with the Trader work station (TWS). The TWS is the application through which members access the trading platform, place orders and execute trades. The TWS offers a multitude of user-friendly trading features which include commodity price ticker, market watch screen displaying best buy, best sell, last traded price, volume for the day, open interest etc., top gainer and loser contracts, net position, on-line backup facility etc.

Trade Timings

Trading on MCX platform takes place on all days of the week (except on Saturdays, Sundays and trading holidays declared by the Exchange) Market timings are as under:

Monday to Friday: 9:00 am to 11:30 pm
(up to 11:55 pm on account of day light savings typically between every November and March of the following year)

  • Agri-commodities are available for futures trading up to 5:00 pm
  • Other commodities such as Bullions, Metals and Energy products are available up to 11:30 pm / 11:55 pm
  • International referenceable Agri-commodities are available up to 9:00 pm as notified by SEBI

Trading on NCDEX Platform happens from Monday to Friday. Market timings segment-wise are as under:

Monday to Friday: 9:00 am to 9:00 pm

  • Crude Palm Oil, Cotton, Kapas, Soy Oil and Sugar: 9:00 am to 9:00 pm
  • All Other Agri Commodities: 9:00 am to 5:00 pm

HOW TO PUT BUY AND SELL ORDERS IN COMMODITIES

The TWS (Trader Work Station) is the front-end for placing orders.

Time Related Conditions

DAY Order: A Day order is valid for the day on which it is entered. If the order is not matched during the day, the order gets cancelled automatically at the end of the trading day.

GTC Order: A Good Till Cancelled (GTC) order is an order that remains in the system until the expiry of the respective contract in which it is entered or until when the same is cancelled by the member.

GTD Order: A Good Till Date (GTD) order is valid till the date specified by the member. After the specified date the unexecuted orders get automatically cancelled by the system.

IOC Order: An Immediate or Cancel (IOC) order allows a member to execute the orders as soon as the same is placed in the market, failing which the order will get cancelled immediately.

Price Related Conditions

Limit Order: The order wherein the price is to be specified while placing the same. The order will only be executed if the market gets a price that is at par or better than the price condition. Buy orders will be at the Limit Price or lower and Sell orders will be at the Limit price or higher. Limit orders work best in volatile market conditions.

Market Order: The order at the best available price at the time of placing the same. These orders will be execute at the best available price in the market subjects to volumes being available. Market orders are useful when you are buying in a falling market or if you are selling in a rising market. You can get better prices through market orders.

UNDERSTANDING VARIOUS TYPES OF MARGINS ON COMMODITY FUTURES

Commodity exchanges follow a stringent margining system for all future and options contracts traded on the Exchange platform. Actual margining and position monitoring is done on an on-line and real time basis. For the purpose of computing and levying the margins, the exchange uses SPAN (Standard Portfolio Analysis of Risk) model which follows a risk-based and portfolio-based approach. The Initial Margin requirement is based on a worst-case loss scenario of portfolio at client level to cover VAR (value at Risk) over a two day horizon, subject to a minimum margin as prescribed by SEBI for the respective commodities.

The SPAN Risk Parameter File (RPF) is generated by the Exchange periodically at pre-defined timings and RPF files so generated are provided to the members and is also made available on the Exchange website.

In addition to SPAN margins, Extreme Loss Margins (ELMs) are levied to cover the tail risk not covered by initial margins. ELMs are also known as exposure margins and are collected in addition to SPAN margins.

In addition, Special margins are also levied whenever deemed necessary considering the volatility and price movement in the commodities.

Tender Period margins and Delivery Period Margins are levied on contracts nearing expiry to ensure non default in commodity delivery. This only pertains to actual delivery of the commodity and not for square off contracts.

The table below captures the key margin details on the long futures, short futures, long options and short options for the key commodities where options trading is permitted in case of the MCX.

Position Initial Margin Extreme Loss Margin Mark to Market Margin Special Margins Comments
Copper Futures Minimum 4% or based on SPAN, which is higher. Minimum 1.00% Calculated on a daily basis from clients when price moves are unfavourable As applicable from time to time based on market volatility conditions Applies to long and short futures
Copper Option Buyer Premium margin is collected upfront N.A. N.A. N.A.
Copper Option Writer Price Scan Range (3.5 Sigma) Volatility Scan Range (5%) Minimum SPAN (2.5%) Minimum 1.25% Calculated on a daily basis from clients when price moves are unfavourable As applicable from time to time based on market volatility conditions Applies to short options only
Zinc Futures Minimum 4% or based on SPAN, which is higher. Minimum 1.25% Calculated on a daily basis from clients when price moves are unfavourable As applicable from time to time based on market volatility conditions Applies to long and short futures
Zinc Option Buyer Premium margin is collected upfront N.A. N.A. N.A.
Zinc Option Writer Price Scan Range (3.5 Sigma) Volatility Scan Range (5%) Minimum SPAN (2.5%) Minimum 1.25% Calculated on a daily basis from clients when price moves are unfavourable As applicable from time to time based on market volatility conditions Applies to short options only
Gold Futures Minimum 4% or based on SPAN, which is higher. Minimum 1.00% Calculated on a daily basis from clients when price moves are unfavourable As applicable from time to time based on market volatility conditions Applies to long and short futures
Gold Option Buyer Premium margin is collected upfront N.A. N.A. N.A.
Gold Option Writer Price Scan Range (3.5 Sigma) Volatility Scan Range (3.5%) Minimum SPAN (2.5%) Minimum 1.25% Calculated on a daily basis from clients when price moves are unfavourable As applicable from time to time based on market volatility conditions Applies to short options only
Silver Futures Minimum 4% or based on SPAN, which is higher. Minimum 1.00% Calculated on a daily basis from clients when price moves are unfavourable As applicable from time to time based on market volatility conditions Applies to long and short futures
Silver Option Buyer Premium margin is collected upfront N.A. N.A. N.A.
Silver Option Writer Price Scan Range (3.5 Sigma) Volatility Scan Range (3.5%) Minimum SPAN (2.5%) Minimum 1.00% Calculated on a daily basis from clients when price moves are unfavourable As applicable from time to time based on market volatility conditions Applies to short options only
Crude Oil Futures Minimum 4% or based on SPAN, which is higher. Minimum 1.00% Calculated on a daily basis from clients when price moves are unfavourable As applicable from time to time based on market volatility conditions Applies to long and short futures
Crude Oil Option Buyer Premium margin is collected upfront N.A. N.A. N.A.
Crude Oil Option Writer Price Scan Range (3.5 Sigma) Volatility Scan Range (5%) Minimum SPAN (2.5%) Minimum 1.00% Calculated on a daily basis from clients when price moves are unfavourable As applicable from time to time based on market volatility conditions Applies to short options only

The table below captures the margin details on the long futures, short futures, long options and short options for key commodities for trading in NCDEX. These pertain to September 2019 contracts

Commodity Initial Margin Extreme Loss Margin Total Margin Additional Margins
Castor Seed 4.00% 3% 7.00%
Chana 4.88% 1% 5.88% 20% on shorts
Coriander 10.57% 3% 13.57%
Cotton Seed Oilcake 8.98% 2% 10.98%
Guar Gum 7.37% 1% 8.37%
Jeera 5.71% 3% 8.71%
Maize Rabi 4.47% 1% 5.47%
Moong 4.03% 1% 5.03%
Mustard Seed 4.00% 1% 5.00%
Refined Soya Oil 4.00% 1% 5.00%
Soybean 4.89% 1% 5.89%
Turmeric 8.36% 3% 11.36%

It needs to be noted that these margins keep changing from time to time depending on price movement, risk and volatility in price movements.

UNDERSTANDING VARIOUS TYPES OF MARGINS ON COMMODITY OPTIONS

In terms of margining, the applicable margins are limited to upfront premium margins only for the buyer of the call and put option. That is because the maximum loss of the buyer of the call or put options is limited to the total premium paid. Since the maximum loss is collected from the buyer of the option in the form of upfront margins, there is no scope for collection of any further margins.

However, the situation is very different in case of writing or selling of options. In this case, the profits of the option writer are limited to the premium received but the losses can be unlimited. Hence the payment of margins by the seller / writer of the commodity option will be exactly similar to the buyer and seller of futures. The only difference is that in case of the seller of the option, the margin liability is adjusted for the premium receivable from writing the option. Otherwise, the formula for margining almost remains the same.

RISK MANAGEMENT IN COMMODITY FUTURES AND OPTIONS TRADING

Risk management in the commodity markets is done through a variety of tools. Here are some of the key tools used for risk management.

Intraday Price Limits

For every commodity, the maximum price movement during a day is limited by the Price Limits prescribed by the Regulator. Price limits (upper and lower) are similar to circuit filters and are based on the Previous Day Closing Price of the Contract in percentage term.

Collection of Margins

This is one of the most important tools of risk management in the commodity market and is done through various types of margins. Let us look the major ones.

  • Initial margin is charged to participants for initiating buy / sell trades and is collected up-front from the clearing members. Initial margin is based on the volatility of the future prices of underlying commodities and is subject to change intraday. Value at Risk (VAR) is a technique used to estimate the probability of loss of value of an asset based on the statistical analysis of historical price trends and covers 2 days risk.
  • VAR based Initial margin on all the commodities future contracts is subject to a minimum percentage defined.
  • Calendar spread position is defined as counter positions created by a client in two different expiries of a commodity. Calendar spread benefit is given to the members, as calendar spread positions are loss off-setting positions. Exchange charges 50% of the Initial Margin on “Calendar spread positions”.
  • Mark to Market (MTM) losses are charged in case the price movement is unfavourable. In case of long futures if price falls and in case of short futures, if price rises then they are liable for MTM margins. MTM margins are collected daily but monitored by the exchange on a real time basis and any tail risks are immediately alerted to the CM and the TM for instant action.
  • Tender Margin is charged by the exchange on contracts during the last 3-5 days of Expiry depending on contract specifications. Such margins are different for different commodities.
  • Delivery Margin are charged on all matched positions from the date of Expiry of the contract to the date of delivery settlement of the contract. The delivery margin percentage is different for different commodities.
  • Apart from all the above margins, Special / Additional margins may be levied by the exchange from time to time. These margins are over and above to the initial margin. These special margins are uni-directional in nature. Additional margins are applicable on both directions of positions.
  • In addition, the regulator has the right to impose Regulatory Margins depending on the need to regulate volatility in such commodity prices.

The exchange treats failure to pay margins quite seriously. The Member who does not have sufficient funds in the Margin account to cover various margins charged by the Exchange shall go into the square off mode. The member will remain in square off mode till margin commitments are either reduced or honoured in full. The Exchange may charge penalty too.

Real-time tracking of mark-to-market (MTM) positions

This is an important aspect of exchange risk management to pre-empt any crisis in the exchange. Profit / loss of all members on all open positions is tracked real time by the Exchange and settled in cash on T+1 day. The MTM of member is settled on a daily basis. This ensures that losses do not accumulate in member’s account.

The MTM pay-in of the Clearing Member is compared with the margin deposits on a real-time basis during trading hours to ensure that the MTM pay-in is always within pre specified limit. When the loss of a member increases beyond the pre specified levels, the system will automatically generate alerts at Trader Workstation. In case the MTM loss reaches/goes beyond upper limit set by the Exchange, the Member shall go into the Square off Mode wherein the member is not allowed to take fresh positions till he funds the pay-in account.

Limits on the maximum order size

As a risk containment measure, the Exchange shall have restrictions on the maximum order size that the Member shall put on the Exchange platform. The Member with higher Margin Limits can increase the single order limit by seeking exchange approval.

Position wise limits for risk control

Position wise limits are the maximum open position that a Member and constituents can have in any commodity / contract at any point of time. Such limits are different for different commodities. Such position Limits are specified at Member and Client levels. Any change in these levels is intimated to members through circulars of the Exchange. Members / client breaching position limit shall be liable to pay penalty to the Exchange for such violation.

HOW CLEARING AND SETTLEMENT WORKS IN COMMODITY DERIVATIVES TRADING?

Clearing and settlement is the last step in the commodity trade process. Clearing refers to determining the obligations of pay-in and pay-out based on net positions of the clients, trading members and clearing members. This hierarchy is maintained both ways. On the other hand, settlement is the actually pay-in and pay-out to the CMs, which is then transmitted to the TM and the actual trading clients.

In case of MCX, the MCX Clearing Corporation (MCXCCL) has entered into an agreement with Multi Commodity Exchange of India Limited (MCX) to provide clearing and settlement services to MCX whereby all trades executed on MCX will be cleared and settled by MCXCCL.

MCXCCL also provides the counter guarantee to each trade by acting as the counterparty. Effectively, the buyer and the seller on the commodity exchange actually deal with the MCCXL as the counterparty, which actually eliminates the default risk in totality. MCXCCL guarantees settlement of all trades executed on MCX by assuming the counter party risk of the Clearing Members for all the trades done on MCX. MCXCCL guarantees its Clearing Members for:

  • Funds pay-out till marking of delivery
  • Financial compensation in case of default after marking of delivery

Clearing and Settlement Division of MCXCCL performs and monitors all activities relating to delivery and fund settlement through a well-defined settlement cycle. MCXCCL has empanelled with several Clearing Banks to provide banking services to the Clearing Members. Once the clearing and settlement is done, that completes the entire settlement process and the trading loop is closed in the commodity exchange.

NCDEX set up a dedicated company to manage its clearing and settlement – NCCL, only in 2018 as per SEBI stipulations. Till then, the clearing and settlement was conducted by the exchange itself in association with the clearing banks. The process of clearing and settlement in case of NCDEX is broadly the same as MCX.

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