Price Risk Management of Cotton using Exchange Futures

Price Risk Management of Cotton using Exchange Futures

Commodity, futures, contract? “Commodity” is a product having commercial value and which can be produced, bought, sold and consumed “Futures” are standardized forward contracts traded on regulated exchanges. “Futures contract” is a contractual agreement between two parties to buy or sell an asset of a specified quantity and quality at a specific time in future at a specific price through the Exchange • The “main functions” of an Exchange traded futures contract are – Ø Trade Guarantee Ø Risk Management Ø Price Discovery Ø Transactional Efficiency Ø Liquidity

Cotton Contracts (Important Features): PARAMETER SPECIFICATION Price Quote Rs. / Bale Trading Unit 25 Bales Tick Size Rs. 10 Contract Months Oct, Nov, Dec, Jan, Feb, Mar, Apr, May, Jun, Jul Expiry Date Last trading day of month Delivery Unit 100 Bales Delivery Logic Compulsory Delivery Maximum Allowable Open Position For Individual Client: 1, 50, 000 bales. For a member collectively for all clients: 15, 000 bales or 15% of the market wide open position whichever is higher. For Near Month Delivery: For Individual Client: 37, 500 bales. For a member collectively for all clients: 3, 75, 000 bales or 15% of the market wide open position whichever is higher.

Trading. .

ICE-MCX Price Correlation (Year wise)

Cotton snapshot Ø App Indian market size : Rs. 60, 000 Crores Ø Annualized price volatility in 2015: 17% Ø Exposure to price risk: More than Rs. 10, 000 Crores ü ü ü ü Since launch MCX has witnessed trading about 10 crore bales Highest single day volume : 5, 56, 000 bales More than 6 lac bales are delivered through MCX since launch Market share almost 100% More than 90% correlation with ICE prices Contract specifications covers more than 75% of cotton grown in India Minimum impact cost due to high liquidity

Daily Volume (Bales) Daily OI (Bales) 16 16 20 7/ /0 01 16 20 6/ /0 01 20 16 20 5/ /0 01 16 20 4/ /0 01 16 16 20 3/ /0 01 2/ /0 01 15 20 1/ /0 01 20 15 20 2/ /1 01 15 20 1/ /1 01 15 20 0/ /1 01 15 15 20 20 9/ /0 01 8/ /0 01 15 15 20 7/ /0 01 6/ /0 01 15 20 5/ /0 01 15 20 4/ /0 01 15 20 3/ /0 01 20 1/ /0 01 MCX Cotton 2015 Onwards Volume & Open Interest 600000 500000 400000 300000 200000 100000 0

Who are all. . . ? Producers: to sell Consumers: to buy Traders : to buy or sell Arbitragers : to exploit the differences between markets Speculators/Investors gain or loose from the preconceived desirous price movement

And you are … ? § to transfer / manage /mitigate the undesired price risk § Ginners – by selling § Yarn mills/ spinning mills – by buying / selling

To put it simple … § Stocks in hand – risk of price falling § Sell NOW in exchange § Stocks required for future – risk of price rising § Buy NOW in exchange

Why this works…? § Future price = spot price + carrying cost § Future and spot prices move in tandem But in past it was different. . !!!! Future price < spot price

Let us get into reality. . Date SPOT price# MCX price (july) Apr’ 15 th 34100 36470 Apr’ 29 th 34700 37285 May’ 16 th 34800 36888 May’ 31 st 36800 38393 Jun’ 15 th 39700 41193 Jun’ 30 th 42700 42468 Jul'15 th 48000 47171 Jul’ 29 th 46600 47004 # price Rs / candy source : SIMA

Spot and futures. . Last 4 months 60000 50000 40000 SPOT price 30000 MCX price 20000 10000 0 Apr’ 15 th Apr’ 29 th May’ 16 th May’ 31 st Jun’ 15 th Jun’ 30 th Jul'15 th Jul’ 29 th Spot (sankar 6) price (rs/candy) – source – SIMA -CBE

You bought stock on Apr 15 th for future ( July ) consumption. . (worried of price going down) In MCX. . 1. On 15 th April – sell MCX @ 36470 2. On 15 th July – buy MCX @ 47171 Date SPOT price MCX price You are in loss of Rs 10701 (47171 – 36470) Apr’ 15 th 34100 36470 Apr’ 29 th 34700 37285 In your business … May’ 16 th 34800 36888 May’ 31 st 36800 38393 Jun’ 15 th 39700 41193 Jun’ 30 th 42700 42468 Jul'15 th 48000 47171 Jul’ 29 th 46600 47004 15 th 1. On Feb – bought @34100 2. On 15 th Apr – consumed @ 48000 You are in a Profit of Rs. 13900 (48000– 34100) NET Profit Rs. 3199 (13900 -10701)

You want to buy on Apr 29 th for Jul 29 th consumption …. ( worried of price going up ) In MCX. . 1. On Apr 29 th – buy MCX may @ 37285 2. On July 29 th – sell MCX may @ 47004 You are in Profit of Rs. 9719 (4700437285) In your business … 1. On Apr 29 th – price @34700 2. On July 29 th – procured @ 46600 You are in a loss of (34700 -46600) Rs. 11900 at business The Net Loss of Rs. 2181 (9719 -11900) against the price rise Date SPOT price MCX price Apr’ 15 th 34100 36470 Apr’ 29 th 34700 37285 May’ 16 th 34800 36888 May’ 31 st 36800 38393 Jun’ 15 th 39700 41193 Jun’ 30 th 42700 42468 Jul'15 th 48000 47171 Jul’ 29 th 46600 47004

Then delivery…? ? ? § Don’t need hedging. . need only physical stock … § Take at the price you bought for the future date (no matter price goes up / down!!!) § how do I do…? § And you get at Rajkot (Base), Kadi, Mundra (Gujarat), Yavatmal, Jalna, Jalgaon (Maharashtra), Sirsa (Haryana), Raichur (Karnataka) and Adilabad (Telugana)

Delivery Process DEPOSITOR WH Yamada/Origo Moisture Testing at WH Samples Drawn (5 Bales) Lab Testing (5 Samples) EXCHANGE ACCREDITED WH Goods Deposited Staking LAB (WAKEFIELD) WH Receipts Issued

DELIVERY CENTERS WITH LOCATION DISCOUNT Sirsa (-250) Kadi Mundra (- 50) Rajkot (Basis) Yavatmal (- 200) Jalna/Jalgaon (- 150) Adilabad (-200) Raichur (- 200)

Oh. . quality. . premium discount? STAPLE LENGTH Below 28 mm = Rejected ` Below 28. 50 to 28. 0 = Discount of 2% 28. 5 to 29. 0 = No Premium/ Discount Above 29. 0 to 30. 0 = Premium 1% Above 30 mm = Premium 2% COLOR GRADE Up to 31 -3=No premium/discount 41 -3 = Discount 5% 42 -3=Discount 6% MICRONAIRE Below 3. 5 = Rejected Below 3. 6 and up to 3. 5 = Discount of 0. 3% 3. 6 to 4. 8 = No Premium/ Discount Above 4. 8 and upto 4. 90 = Discount of 0. 3% Above 4. 9 = Rejected TRASH Below 3. 5% and up to 2% = Premium Of 1: 0. 5 Basis = 3. 5% Up to 5% = Discount 1: 1 Above 5% = Rejected MOISTURE Basis = 8. 5% Up to 9. 5% = 1: 1 Discount Above 9. 5% = Rejected STRENGTH Minimum 28 GTex

MCX Transaction Charge Lot Size Price Quote Tick Size Tick value 25 bales Rs. Per Bale (of 170 kg. each) Price (assumed) 20, 000 10 Contract Value 5, 000 250 Turnover (both sides) 10, 000 MCX Transaction Charge 50 Paisa/ L T. O. Charge/ Lot (Buy + Sell) Rs 5. 00

Cost of Delivery ( Indicative) Approximate cost for giving delivery of 100 bales Rs/100 bale Sampling & Assayer 's charges (per 100 bale) 3000 Unloading & Stacking at Ware house Rs 20/bale 2000 Ware house charges @ Rs 1. 50/bale/day 150/day Standard deduction for one month 0. 35% (Assume price Rs 20, 000/bale) 7000 Total 12150

KEY LIQUIDITY DIMENSIONS MEASURES Ø Trading volumes DEPTH ØIncreased Liquidity in mid-months ØNumber of participants ØImpact cost

MONTH-WISE DELIVERY & STOCKS Month-wise Delivery of cotton at MCX Platform Expiry date Qty (Bales) October, 30, 2015 600 November 30, 2015 4, 600 December 31, 2015 5, 500 January 30, 2016 9, 700 February 29, 2016 7, 800 March 31, 2016 14, 500 April 29, 2016 14, 100 May 31, 2016 19, 700 June 30, 2016 2, 700 July 29, 2016 4, 200 Total (October 2015 to July 2016) 83, 400

What is in it for me…? § § § Margin money (5%) Volumes Assured quality Assured delivery Brokers at your next door KOTAK –CBE.

Thank You All views expressed in this presentation are based on the personal opinion of the author, looking at historical data, past trends and own understanding of market, and are not to be construed as an assurance or guarantee of any kind of return or profit. Market participants are expected to conduct all due diligence on their own before trading. The author or sender or presenter of this presentation shall not be liable for any trading loss incurred, under any circumstances, whatsoever.