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FUNDAMENTAL ANALYSIS & SPREAD TRADING OF CHANA COMMODITY

INTRODUCTION:
1) About the Organization:
PJ Commodity Ventures have over 125 years of collective experience in commodity markets. This encompasses the whole gamut of financial markets futures, hedging, consultancy, training, information systems, risk management, fundamental and technical research, portfolio and wealth management, and in setting up and managing exchanges. They have a strong background in the agricultural value-chain. Professionals qualified in Commerce, Economics, Agriculture, Plantation and Engineering Science. Management and Specialized qualifications in Portfolio Management and internationally certified Technical Analyst's make research team and work on various aspects of commodity trading. PJ Commodity Ventures aids the players of physical commodity business to hedge their price risk through futures markets. They offer consultancy through specialized teams, Trade advisory, training, market knowledge and risk management solutions. PJ Commodity Ventures creates innovative products and tailor-made solutions through their core research team. They are developing leadership in agricommodity futures and options. In their core corporate products, they offer Customized research, Training program, Corporate MIS reports, Risk management solutions, etc. The research team covers the total commodity futures/options markets and serves a variety of market participants who use the markets for their hedging and price-fixing needs. They have web based trading and regular commodity newsletters with relevant practical information.
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FUNDAMENTAL ANALYSIS & SPREAD TRADING OF CHANA COMMODITY

PJ Commodity Ventures targets a diverse client base, ranging from Corporate, physical commodity traders, institutions and farmers to professional traders and private clients. Their corporate clients use our research for their hedging needs and their web based trading facility gives them the requisite privacy in their dealings. They are one of the few members offering web based commodity trading. Now web based trading is different from online trading. For online trading, one needs to download a software and can trade only from that terminal, whereas in web based solution one can trade from any place with Internet connectivity. Their institutional and private clients are able to access commodity markets from any place, even while on the move, and still get the benefit of the latest order entry, routing and risk management technologies. To cap it all, their web based trading system is designed to offer complete secrecy of one's trade. Being web based commodity broking; their client base is spread over the universe. Taking advantage of the location, they have experienced people in all the south Indian states of Andhra Pradesh, Karnataka, Kerala and Tamil Nadu; with offices in key financial centers of Bangalore, Chennai, Cochin and Hyderabad. As participants of agricultural value chain they will shortly be setting up offices at important trading centers in the far reaches of the country.

2) COMMODITY TRADING:
2.1. COMMODITY

A commodity may be defined as an article, a product or material that is bought and sold. It can be classified as every kind of movable property, except Actionable
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Claims, Money & Securities. Any good that is unbranded and is commonly traded in the market is a commodity. Commodities actually offer immense potential to become a separate asset class for market-savvy investors, arbitrageurs and speculators. Retail investors, who claim to understand the equity markets, may find commodities an unfathomable market. But commodities are easy to understand as far as fundamentals of demand and supply are concerned. Retail investors should understand the risks and advantages of trading in commodities futures before taking a leap. Historically, pricing in commodities futures has been less volatile compared with equity and bonds, thus providing an efficient portfolio diversification option.

2.2. COMMODITY MARKETS


Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts. Commodity market is an important constituent of the financial markets of any country. It is the market where a wide range of products, viz., precious metals, base metals, crude oil, energy and soft commodities like palm oil, coffee etc. are traded. It is important to develop a vibrant, active and liquid commodity market. This would help investors hedge their commodity risk, take speculative positions in commodities and exploit arbitrage opportunities in the market.

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FUNDAMENTAL ANALYSIS & SPREAD TRADING OF CHANA COMMODITY

2.3. EVOLUTION OF COMMODITY MARKET IN INDIA


Bombay Cotton Trade Association Ltd., set up in 1875, was the first organized futures market. Bombay Cotton Exchange Ltd. was established in 1893 following the widespread discontent amongst leading cotton mill owners and merchants over functioning of Bombay Cotton Trade Association. The Futures trading in oilseeds started in 1900 with the establishment of the Gujarati Vyapari Mandali, which carried on futures trading in groundnut, castor seed and cotton. Futures' trading in wheat was existent at several places in Punjab and Uttar Pradesh. But the most notable futures exchange for wheat was chamber of commerce at Hapur set up in 1913. Futures trading in bullion began in Mumbai in 1920. Calcutta Hessian Exchange Ltd. was established in 1919 for futures trading in raw jute and jute goods. But organized futures trading in raw jute began only in 1927 with the establishment of East Indian Jute Association Ltd. These two associations amalgamated in 1945 to form the East India Jute & Hessian Ltd. to conduct organized trading in both Raw Jute and Jute goods. Forward Contracts (Regulation) Act was enacted in 1952 and the Forwards Markets Commission (FMC) was established in 1953 under the Ministry of Consumer Affairs and Public Distribution. In due course, several other exchanges were created in the country to trade in diverse commodities.

2.4. TYPES OF COMMODITIES TRADED


World-over one will find that a market exits for almost all the commodities known to us. These commodities can be broadly classified into the following:

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FUNDAMENTAL ANALYSIS & SPREAD TRADING OF CHANA COMMODITY

Precious Metals: Gold, Silver, Platinum etc Other Metals: Nickel, Aluminum, Copper etc Agro-Based Commodities: Wheat, Corn, Cotton, Oils, Oilseeds, Chana. Soft Commodities: Coffee, Cocoa, Sugar etc Live-Stock: Live Cattle, Pork Bellies etc Energy: Crude Oil, Natural Gas, Gasoline etc

2.5. REGULATORY BODY


Commodity trading in India is regulated by the Forward Markets Commission (FMC) headquartered at Mumbai, it is a regulatory authority which is overseen by the Ministry of Consumer Affairs and Public Distribution, Govt. of India. It is a statutory body set up in 1953 under the Forward Contracts (Regulation) Act, 1952. The commodity futures market is regulated under the provisions of the Forward Contracts (Regulation) Act, 1952 (FCR Act).

2.6. SEGMENTS OF COMMODITY MARKET The commodities market exits in two distinct forms namely the Over the Counter (OTC) market and the Exchange based market. Also, as in equities, there exists the spot and the derivatives segment. The spot markets are essentially over the counter markets and the participation is restricted to people who are involved with that commodity say the farmer, processor, wholesaler etc. Derivative trading takes place through exchange-based markets with standardized contracts, settlements etc.

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FUNDAMENTAL ANALYSIS & SPREAD TRADING OF CHANA COMMODITY

OTC COMMODITY MARKET

The OTC markets are essentially spot markets and are localized for specific commodities. Almost all the trading that takes place in these markets is delivery based. The buyers as well as the sellers have their set of brokers who negotiate the prices for them. This can be illustrated with the help of the following example: A farmer, who produces castor, wishing to sell his produce, would go to the local mandi. There he would contact his broker who would in turn contact the brokers representing the buyers. The buyers in this case would be wholesalers or refiners. In event of a deal taking place the goods and the money would be exchanged directly between the buyer and the seller.

This market is restricted to only those people who are directly involved with the commodity. In addition to the spot transactions, forward deals also take place in these markets. However, they too happen on a delivery basis and hence are restricted to the participants in the spot markets.

2.7. COMMODITY EXCHANGES

LARGEST COMMODITY EXCHANGES: CME- USA Tokyo Commodity Exchange- Japan NYXE Euronext- EU

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FUNDAMENTAL ANALYSIS & SPREAD TRADING OF CHANA COMMODITY

Dalian Commodity Exchange Exchange- China Multi Commodity Exchange Exchange- India Inter Continental Exchange Exchange- US, Canada, China, UK

STRUCTURE OF INDIAN EXCHANGE BASED COMMODITY MARKET

Ministry of consumer affairs

FMC

Commodity exchanges

National

Regional

NCDEX

MCX

NMCE

NBOT

20 other regional exchanges

LEADING INDIAN IAN COMMODITY EXCHANGES

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1. Multi Commodity Exchange (MCX) 2. National Commodity and Derivatives Exchange (NCDEX) 3. National Multi-Commodity Exchange (NMCE) 4. Indian Commodity Exchange (ICEX)

TRADING VOLUMES Trading volumes in Indias commodity exchanges in April 2011 to March 2012 has risen 53.89% to Rs 173,69,550.60 cr as against Rs 112, 86,676.02 cr, according to market regulator Forward Markets Commission. Total value of trading at the Commodity Exchanges during the fortnight, 1st March, 2012 to 15th March, 2012 was Rs 7,45,970.19 crore. The

corresponding figure for March 1-15 the previous year were Rs 6, 94,020.49 crore.

MCX

Headquartered in Mumbai, Multi Commodity Exchange of India Ltd (MCX) is a state-of-the-art electronic commodity futures exchange. The demutualised Exchange set up by Financial Technologies (India) Ltd (FTIL) has permanent recognition from the Government of India to facilitate online trading, and clearing and settlement operations for commodity futures across the country.

Having started operations in November 2003, today, MCX holds a market share of over 80% of the Indian commodity futures market, and has more than 2000
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registered members operating through over 100,000 trader work stations, across India. The Exchange has also emerged as the sixth largest and amongst the fastest growing commodity futures exchange in the world, in terms of the number of contracts traded in 2009 and the turnover of the exchange for the fiscal year 2009 was US$ 1.24 trillion MCX has also set up in joint venture the MCX Stock Exchange. Earlier spin-offs from the company include the National Spot Exchange, an electronic spot exchange for bullion and agricultural commodities, and National Bulk Handling Corporation (NBHC) India's largest collateral management company which provides bulk storage and handling of agricultural products.

MCX offers more than 40 commodities across various segments such as: METAL BULLION

Aluminium, Copper, Lead, Nickel, Steel Gold, Gold HNI, Gold M, i-gold, Silver, Long (Bhavnagar), Steel Long Silver HNI, Silver M

(Govindgarh), Steel Flat, Tin, Zinc FIBER ENERGY

Cotton L Staple, Cotton M Staple, Brent Crude Oil, Crude Oil, Furnace Cotton S Staple, Cotton Yarn, Kapas Oil, Natural Gas, M. E. Sour Crude Oil, ATF, Electricity(Now delisted), Carbon Credit SPICES Cardamom, Jeera, Pepper, Red Chilli PLANTATION Arecanut, Cashew Kernel, Coffee

(Robusta), Rubber PULSES PETROCHEMICALS

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Chana, Masur, Yellow Peas OIL AND SEEDS

DPE, Polypropylene(PP), PVC

Castor Oil, Castor Seeds, Coconut Cake, Coconut Oil, Cotton Seed, Crude Palm Oil, Groundnut Oil, Kapasia Khalli, Mustard Oil, Mustard Seed (Jaipur), Mustard Seed (Sirsa), RBD Palmolein, Refined Soy Oil, Refined Sunflower Oil, Rice Bran DOC, Rice Bran Refined Oil, Sesame Seed, Soymeal, Soy Bean, Soy Seeds CEREALS Maize, Barley OTHERS Guargum, Guar Seed, Gurchaku,

Mentha Oil, Potato (Agra), Potato (Tarkeshwar)

MCX has been certified to three ISO standards including ISO 9001:2000 Quality Management System standard, ISO 14001:2004 Environmental Management System standard and ISO 27001:2005 Information Security Management System standard. The Exchanges platform enables anonymous trades, leading to efficient price discovery. Moreover, for globally-traded commodities, MCXs platform enables domestic participants to trade in Indian currency.

The Exchange strives to be at the forefront of developments in the commodities futures industry and has forged strategic alliances with various leading International Exchanges, including Euronext-LIFFE, London Metal Exchange (LME), New York Mercantile Exchange, Shanghai Futures Exchange (SHFE), Sydney Futures Exchange, The Agricultural Futures Exchange of Thailand (AFET), among others. For MCX, staying connected to the grassroots is imperative. Its domestic alliances aid in improving ethical standards and providing services and facilities for overall improvement of the commodity futures market.
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Key shareholders Promoted by FTIL, MCX enjoys the confidence of blue chips in the Indian and international financial sectors. It is regulated by the Forward Markets Commission. MCX is India's No. 1 commodity exchange with 83% market share in 2009 The exchange's main competitor is National Commodity & Derivatives Exchange Ltd Globally, MCX ranks no. 1 in silver, no. 2 in natural gas, no. 3 in crude oil and gold in futures trading The highest traded item is gold. MCX COMDEX is India's first and only composite commodity futures price index

NCDEX

National Commodity & Derivatives Exchange Limited (NCDEX) is a professionally managed on-line multi commodity exchange. The shareholders of NCDEX comprises of large national level institutions, large public sector bank and companies. NCDEX is a nation-level, technology driven de-mutualised on-line commodity exchange with an independent Board of Directors and professional management. NCDEX is regulated by Forward Markets Commission. NCDEX is subjected to various laws of the land like the Forward Contracts (Regulation) Act, Companies Act, Stamp Act, Contract Act and various other legislations.

NCDEX headquarters are located in Mumbai and offers facilities to its members
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from

the

centres

located

throughout

India.

The commodities contracts offered by NCDEX are as follows: AGRI-BASED COMMODITIES BULLION 1 KG 100gm 30 KG

Castor Seed, Chana, Chilli, Coffee - Gold Arabica, Coffee Robusta, Cotton Seed Gold Oilcake, Crude Palm Oil, Expeller Silver Mustard Oil, Groundnut (in shell), Silver 5 KG Groundnut Expeller Oil, Guar gum, Guar Seeds, Gur, Jeera, Jute sacking bags, Kidney Beans, Indian 28 mm Cotton, Indian 31 mm Cotton, Masoor Grain Bold, Medium Staple Cotton, Mentha Oil, Mulberry Green Cocoons, Mulberry Raw Silk, Rapeseed - Mustard Seed, Pepper, Raw Jute, RBD

Palmolein, Refined Soy Oil, Rubber, Sesame Seeds, Soy Bean, Sugar Small, Sugar Medium, Turmeric, Urad (Black Matpe), V-797 Kapas, Yellow Peas, Yellow Red Maize, Yellow Soybean Meal. FERROUS METALS Mild Steel Ingot ENERGY Brent Furnace
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Crude

Oil Oil
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Light

Sweet

Crude

Oil.

NON-FERROUS METALS Aluminum Copper Nickel Zinc Cathode

PLASTICS Ingot, Polypropylene Cathode Linear Low Density Polyethylene Chloride.

Ingot Polyvinyl

The top 5 commodities, in terms of volume traded at the Exchange, were Rape/Mustard Seed, Gaur Seed, Soyabean Seeds, Turmeric and Jeera. NCDEX also offers as an information product, an agricultural commodity index. This is a composite index, called NCDEXAGRI that converts 20 commodities currently being offered for trading by NCDEX. This is a spot-price based index. NCDEX also offers as an information product, the index futures, called FUTEXAGRI. This is essentially a what-if index. It indicates that if futures on the index could be traded, then the current FUTEXAGRI value should be the noarbitrage value for the index futures. However, indexes and index futures are not allowed to be traded under the current regulatory structure.

NMCE

The first state-of-the-art demutualised multi-commodity Exchange, National Multi Commodity Exchange of India Ltd. (NMCE) was promoted by commodityrelevant public institutions, viz., Central Warehousing Corporation (CWC), National Agricultural Cooperative Marketing Federation of India (NAFED), Gujarat Agro-Industries Corporation Limited (GAICL), Gujarat State Agricultural

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Marketing Board (GSAMB), National Institute of Agricultural Marketing (NIAM), and Neptune Overseas Limited (NOL).

NMCE is a zero-debt company; following widely accepted prudent accounting and auditing practices. It has robust delivery mechanism making it the most suitable for the participants in the physical commodity markets. The exchange does not compromise on its delivery provisions to attract speculative volume. Public interest rather than commercial interest guide the functioning of the Exchange. It has also established fair and transparent rule-based procedures and demonstrated total commitment towards eliminating any conflicts of interest. It is the only Commodity Exchange in the world to have received ISO 9001:2000 certification from British Standard Institutions (BSI).

NMCE commenced futures trading in 24 commodities on 26th November, 2002 on a national scale and the basket of commodities has grown substantially since then to include cash crops, food grains, plantations, spices, oil seeds, metals & bullion among others.

The commodities traded are as follows: OIL & OIL SEEDS SPICES & PULSES

Castor seeds 10MT, Copra, Rape/ Pepper, Cardamom, Turmeric, Chana Mutard seeds, Soya bean oil PRECIOUS METALS BASE METALS

Gold Guinea, Gold (100gms), Gold Aluminium, Copper, Lead, Nickel, Zinc (1kg), Silver AGRO-BASED PRODUCTS & FIBERS
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FUNDAMENTAL ANALYSIS & SPREAD TRADING OF CHANA COMMODITY

Rubber, Raw jute, Methol, Isabgul seeds, Kalyan Kapas V-797, Sacking, Coffee REP bulk, Guar seeds, Guar gum, Wheat

NMCE was the first commodity exchange to provide trading facility through internet, through Virtual Private Network (VPN). NMCE follows best international risk management practices. The contracts are marked to market on daily basis. The system of upfront margining based on Value at Risk is followed to ensure financial security of the market. The unique strength of NMCE is its settlements via a Delivery Backed System, an imperative in the commodity trading business. These deliveries are executed through a sound and reliable Warehouse Receipt System, leading to guaranteed clearing and settlement.

ICEX

Indian Commodity Exchange Limited is a screen based on-line derivatives exchange for commodities and has established a reliable, time tested, and a transparent trading platform. It is also in the process of putting in place robust assaying and warehousing facilities in order to facilitate deliveries. It is jointly promoted by Indiabulls Financial Services Ltd and MMTC Limited, and has Indian Potash Ltd., KRIBHCO and IDFC among others, as its partners.

This exchange is ideally positioned to tap the huge scope for increasing the depth and size of commodities market and fill in the structural gaps existing in the Indian market. Our head office is located in North India (Gurgaon), one of the key
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regions in India's Agri belt, with a vision to encourage participation of farmers, traders and actual users to hedge their positions against the wild price fluctuations. The commodities traded are as follows:

PRECIOUS METALS Gold, Silver METALS Aluminium, Copper, Lead, Nickel, Zinc

ENERGY Crude oil, Natural gas OIL & OIL COMPLEX Mustard seed, Soybean, Soya oil, Palm oil

SPICES, PULSES & FIBERS

OTHER AGRO PRODUCTS

Black pepper, Jeera, Turmeric, Chana, Guar Seed, Mentha oil Raw Jute

2.8. COMMODITY DERIVATIVES


Derivatives as a tool for managing risk first originated in the commodities markets. Commodity future is a derivative instrument for the future delivery of a commodity on a fixed date at a particular price. The underlying in this case is a particular commodity. If an investor purchases an oil future, he is entering into a contract to buy a fixed quantity of oil at a future date. The future date is called the contract expiry date. The fixed quantity is called the contract size. These futures can be bought and sold on the commodity exchanges.

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DIFFERENCE DERIVATIVE

BETWEEN

COMMODITY

AND

FINANCIAL

The basic concept of a derivative contract remains the same whether the underlying happens to be a commodity or a financial asset. However there are some features, which are very peculiar to commodity derivative markets. In the case of financial derivatives, most of these contracts are cash settled. Even in the case of physical settlement, financial assets are not bulky and do not need special facility for storage. Due to the bulky nature of the underlying assets, physical settlement in commodity derivatives creates the need for warehousing. Similarly, the concept of varying quality of asset does not really exist as far as financial underlying are concerned. However in the case of commodities, the quality of the asset underlying a contract can vary largely. This becomes an important issue to be managed.

BENEFITS OF COMMODITY FUTURES To producer: A producer of a commodity can sell the futures of the commodity, thereby ensuring that he can sell a particular quantity of his commodity at a particular price at a particular date.

To investors: An investor has alternative investment instruments where he can take a position as to future price and the spot price at a particular date in future and buys and sells options. He is not interested in taking deliveries of the commodities.

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To commodity trader: A commodity trader can use these to ensure that he is protected against any adverse changes in the prices. He can enter into a futures contract for purchase of a certain quantity of the underlying at a particular price on a particular date, or he can enter into a futures contract for sale of a particular quantity on a particular date at a particular price and be assured of the margins because both his purchase price as well as the sale price are fixed. Traders do a good arbitrage in Gold and Silver. Whenever they find Gold moving up, they short silver and similarly whenever they find silver moving up and gold likely to move down, they hedge. To exporters: Future trading is very useful to the exporters as it provides an advance indication of the price likely to prevail and thereby help the exporter in quoting a realistic price and thereby secure export contract in a competitive market. Having entered into an export contract, it enables him to hedge his risk by operating in futures market.

WHY COMMODITY FUTURES In India agriculture has traditionally been an area with heavy government intervention. Government intervenes by trying to maintain buffer stocks, they try to fix prices, and they have import-export restrictions and a host of other interventions. Many economists think that we could have major benefits from liberalization of the agricultural sector. In this case, the question arises about who will maintain the buffer stock, how will we smoothen the price fluctuations, how will farmers not be vulnerable that tomorrow the price will crash when the crop comes out, how will farmers get

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signals that in the future there will be a great need for wheat or rice. In all these aspects the futures market has a very big role to play. If you think there will be a shortage of wheat tomorrow, the futures prices will go up today, and it will carry signals back to the farmer making sowing decisions today. In this fashion, a system of futures markets will improve cropping patterns. Next, if I am growing wheat and am worried that by the time the harvest comes out prices will go down, then I can sell my wheat on the futures market. I can sell my wheat at a price, which is fixed today, which eliminates my risk from price fluctuations. These days, agriculture requires investments -- farmers spend money on fertilizers, high yielding varieties, etc. They are worried when making these investments that by the time the crop comes out prices might have dropped, resulting in losses. Thus a farmer would like to lock in his future price and not be exposed to fluctuations in prices. The third is the role about storage. Today we have the Food Corporation of India, which is doing a huge job of storage, and it is a system, which -- in my opinion -does not work. Futures market will produce their own kind of smoothing between the present and the future. If the future price is high and the present price is low, an arbitrager will buy today and sell in the future. The converse is also true, thus if the future price is low the arbitrageur will buy in the futures market. These activities produce their own "optimal" buffer stocks, smooth prices. They also work very effectively when there is trade in agricultural commodities; arbitrageurs on the futures market will use imports and exports to smooth Indian prices using foreign spot markets.

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In totality, commodity futures markets are a part and parcel of a program for agricultural liberalization. Many agriculture economists understand the need of liberalization in the sector. Futures markets are an instrument for achieving that liberalization.

2.9. COMMODITY TRADING Commodity trading is done through the exchanges, especially the national
exchanges, which have electronic trading and settlement systems.

Minimum investment-Rs.5000/-For trading in bullion (gold and silver),


minimum amount required is Rs 650 and Rs 950 for on the current price of approximately Rs 65,00 for gold for one trading unit (10 gm) and about Rs 9,500 for silver (one kg).

Margins 5-10% of commodity contract


Both delivery and settlement in cash is permitted. If you want your contract to be cash settled, you have to indicate at the time of placing the order that you don't intend to deliver the item. If you plan to take or make delivery, you need to have the required warehouse receipts. The option to settle in cash or through delivery can be changed as many times as one wants till the last day of the expiry of the contract. Sales tax is applicable only in case of trade resulting into delivery. Normally it is the seller's responsibility to collect and pay sales tax. The sales tax is applicable at the place of delivery.

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FUTURE TRENDS IN COMMODITY MARKETS: INDIA India: Being in a time-zone that falls in the gap left by the major commodity exchanges in the US, Europe and Japan has also worked in Indias favour because commodity business by its very nature is a 24/7 business. Innovation coupled with modern and successful financial market environment has ensured the beginning of a success story in commodities which will eventually see India becoming a pricesetter in major commodities on the strength of its large production and consumption.

It is pertinent to note that India and China are being projected as the major drivers for the initiation of yet another commodity super-cycle. Tracking price trends and analyzing the statistics have always been key areas of economic research; but in each cycle whether defined by Jim Rogers, Kondratieff or Dewey & Dakin the trigger is always different, and in this case it may well be increase in regional consumption, some of which we have already seen. One outcome of the recent boom-bust cycle has been that mergers and acquisitions have gained speed and the biggest beneficiaries will likely be large companies from historically conservative countries, like India. This phase is likely to propel India into the international big league quicker and on a firmer footing. In fact, India did well to weather the global financial crisis over the last year and a half, with GDP growing at 6% at the worst of times, compared to almost every other country which showed negative growth in one or more quarters during this period. Growth did fall from 9% to 6% but was way above the World Banks forecast of 4%, demonstrating economic resilience, a sure sign of things to come. It would

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seem that the alignment of growth with commodities is the most likely outcome to underline the changing world economic order.

In addition to futures trading, the number of Indians looking at commodities as part of their investment portfolio is fast reaching critical mass, as gold demonstrates. Add to that a state-of-the-art infrastructure for trading and the availability of trained personnel, and you have a ready market for businesses wishing to hedge their risks as the markets become more and more globalised on account of the removal of trade barriers worldwide. With a conductive financial environment, the commodity markets in India have come of age and benefits are accruing to those who are most willing to identify consumer needs and service them.

3) Spread Trading in Commodities Futures

3.1

Background:

Let us first familiarize ourselves with some of the terms used in commodity market

Bullion:-

Precious metals such as Gold and Silver in the form of Bars and Ingots, which are serially numbered and cast in standardized sizes, quality and weights is commonly referred to as Bullion.

Closing Price:-

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At the end of the day's trading session, the exchange online trading system calculates the closing price of each and every contract traded on the system. It is the weighted average price of all the trades that have taken place during last 30 minutes. If the number of trades during the last 30 minutes is less than 5, then it is calculated on the weighted average price of the last 5 trades executed on that trading day. If this number of trades is also less than 5, then the weighted average of all trades executed during the day is taken for it. If no trades have been executed in the contract for the entire day, then the official closing price of the previous day or session is taken for the purpose.

Cash Market:-

It is a place where actual commodities are bought or sold for immediate delivery settlement.

Inverted Market:-

A futures market in which the near month futures contracts are selling at prices higher than the more distant months, usually showing characteristics of immediate supply shortages.

Forward Contract:-

A contractual agreement between two parties to buy or sell an asset at a future date for a specific negotiated Price, Terms and Conditions as agreed upon while signing the agreement. This is not a standardized contract and hence it is not traded on an
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exchange. It is the oldest and simplest form of derivative contract.

Futures Contract:-

Futures contract is a contractual agreement between two parties to buy or sell a commodity of a specified and standardized quantity and quality at a specific time in future at a specific price through the Exchange.

Forward Market Commission:-

FMC is a regulatory authority which is overseen by the Ministry of Consumer Affairs and Public Distribution, Government of India. It is a statutory body set up in 1953 under the Forward Contracts (Regulation) Act, 1952. This is the regulating authority for all Commodity Derivatives Exchanges in India.

Warehouse Receipt:-

Warehouse receipts are title documents issued by warehouses to depositors against the commodities deposited in the warehouses. These documents are transferred by endorsement or delivery. The original depositor or the holder in due course can claim the commodities from the warehouse by producing the warehouse receipt. The holder of the endorsed warehouse receipt can claim ownership of the commodity.

Contract Specification: -

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Contract specification is a document, which provides detailed guidelines and parameters of any relevant commodity traded on the exchange. The contract ensures the standards of commodity futures through various parameters such as trading details, contract duration or expiry date, quality parameters, delivery mode and its details. It includes every possible detail for the successful execution of the trade conducted on the exchange.

Delivery:-

The tender and receipt of the actual commodity, the cash value of the commodity or of a delivery instrument covering the commodity (e.g., warehouse receipts) used to settle a futures contract.

Delivery Month:-

The specified month within which a futures contract matures (expires) and can be settled by delivery.

Delivery Unit:-

It is the quantity of a commodity specified in the contract as a deliverable lot. It usually takes into account the existing trade practices and logistics.

Delivery Centre:-

It is the place or location of the various exchange-designated or approved


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warehouses where the members are obliged to tender the delivery of the commodity.

Delivery pay-in of commodities:-

It refers to the seller delivering the commodity to the exchange-specified warehouse during the tender / delivery period of the contract.

Delivery pay-out of commodities:-

It refers to the time period when the buyer lifts the commodity from the exchange specified warehouse.

Delivery Period Margin:-

It is the extra margin imposed by the exchange on the contracts when it enters the concluding phase (starts with tender period and goes up to delivery / settlement period). This amount is applicable on both the outstanding long and short positions.

Dematerialization:-

It is a process whereby any paper indicating ownership of commodities or securities is converted from physical form into electronic form. Warehouse receipts are a pre-requisite for this process in the commodities market.

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Due Date Rate:-

It is the rate at which the contract is settled on the expiry date. Usually it is the average of the spot prices of the last few trading days (as specified by the exchange) before the contract maturity.

Open Outcry:-

Method of public auction for making verbal offers in the trading pits or rings of commodity exchanges

Arbitrage:

Arbitrage is making purchases and sales simultaneously in two different markets to profit from the price differences prevailing in those markets. The factors driving arbitrage are the real or perceived differences in the equilibrium price as determined by supply and demand at various locations.

Cash and Carry Arbitrage:-

Cash and carry arbitrage means buying physical commodity with borrowed funds and simultaneously selling the futures contract. The physical commodity is delivered upon expiry of the contract. This opportunity arises when the futures price of the asset is more than the sum of spot price and the cost of carrying it till the expiry date.

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Reverse Cash and Carry Arbitrage:-

In the reverse cash and carry arbitrage, one sells the physical commodity and the money thus realized is credited out in the market and simultaneously he buys similar quantity in the futures market. This opportunity arises when the futures price of the asset is less than the sum of the spot price and the cost of carrying.

Hedging:-

It means taking a position in the futures or option market that is opposite to a position in the physical market. It reduces or limits risks associated with unpredictable changes in price. The objective behind this mechanism is to offset a loss in one market with a gain in another. Rolling over of hedge position means the closing out of existing position in the futures contract and simultaneously taking a new position in a futures contract with a later date of expiry.

Hedge Ratio:-

Hedge ratio is the ratio of number of futures contracts to be purchased or sold, to the quantity of cash asset that is required to be hedged. It is calculated as product of the coefficient of correlation between the change in cash prices and the change in futures prices, and the ratio between the standard deviation of the change in cash price and the standard deviation of the change of futures prices of the commodity. It is significant because the spot price and futures price may not vary in the same proportion. By using this ratio, one can cover his basis risk, which is the difference between the spot and future price.
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Long:One who has bought a futures contract or owns a cash commodity.

Buying Hedge (or Long Hedge):-

Buying futures contracts to take an opposite position (selling) in the physical commodity market is called a Buying Hedge (or Long Hedge). This is used by manufacturers / traders / exporters / importers and other participants in the commodity ecosystem to lock in a profit or to protect from possible escalation in commodity prices

Long Position:-

It is the purchase of a futures contract in anticipation of an actual purchase in the cash market. It can be used by processors or exporters as protection against rise in cash prices.

Speculator:-

A speculator is one who enters the market to profit from the future price movements. He does not have any physical exposure. Speculators accept the risk that hedgers seek to avoid, giving the required liquidity to the market.

Ask (also called "offer"):-

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It indicates willingness to sell a futures contract at a given price. It is important to understand whether the bid - ask quote is viewed from the Market Maker's perspective or the Market Taker's perspective.

Bid:

It is a price which the market participants are willing to pay to buy a futures contract on underlying commodity.

Contango:

It is a market condition in which the spot price of the commodity is less than the futures contract price of the underlying commodity.

Backwardation: -

It is a market condition in which commodity futures prices are lower than the spot price of the physical commodity.

Clearing House:-

Clearing house of the exchange performs every activity related to delivery, settlement, margins and managing the settlement guarantee fund. The clearing house will manage margin of the members, effect pay-in and pay-out and monitor delivery and settlement process.

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Commodity:-

Commodity is a product having commercial value that can be produced, bought, sold and consumed. It is normally in a basic raw unprocessed state. But products derived from primary sector and structured products are also traded at these exchanges. In India, the list includes precious metals, ferrous and non-ferrous metals, spices, pulses, plantation crops, sugar and other soft commodities.

Commodity Exchange:-

A commodity exchange is an association or a company or any other body corporate that is organizing futures trading in commodities. The new generation national level exchanges have been set up in a corporatized/demutualised environment. There are 3 nationally recognized commodity exchanges in India and about 21 regional exchanges.

Leverage:-

It is the margin multiplier number to arrive at the market value of the commodity futures contract. Commodity future contracts are highly leveraged instruments as the margin required is usually in the range of 4 -10% of the contract value. Hence the purchasable contract value can be 10-25 times of the margin money.

Broker:-

It is a company or individual that places buy or sell orders for futures contracts on
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behalf of itself or himself respectively on the proprietary book account, or on behalf of financial and commercial institutions and/or the general public for a consideration (brokerage).

Brokerage:-

A fee charged by a broker for execution of a transaction; an amount per transaction or a percentage of the total value of the transaction; usually referred to as a commission fee.

Base price:-

Base price for existing futures contracts is normally taken as the official closing price of the contract during the previous trading session. However, at the time of making the contract available for trading on the system for the first time (at the time of listing a commodity for trading), the exchange decides the base price of the contract based on the spot market price of the commodity on the previous days and a notional carrying cost as the case may be. Base Value The standard unit based on which the price of the contract is quoted for trading is called quotation or base value. E.g. For gold contract, the quotation or base value is 10 gram.

Convergence:-

The phenomenon by which futures prices and spot prices come together as the expiry date of the futures contract approaches is called convergence.

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Basis:

The difference between the spot price of the underlying commodity at a specific location and the price of the respective futures contract on the underlying commodity is called the basis. Mathematically, the Basis is calculated as per the following equation: Basis = Spot Price - Futures Price

Basis Risk

The risk associated with an unexpected widening or narrowing of basis between the time a hedge position is established and the time that it is unwound. In other words, it indicates the risk associated with the potential change in the difference between the spot price of a commodity and the corresponding futures price of the same underlying commodity.

Bear:-

An individual who believes commodity prices to decrease in the medium to longer term and hence expects that the futures contract prices will move lower.

Bull:-

An individual who believes commodity prices to increase in the medium to longer term and hence expects that the futures contract prices will move higher.

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Best Ask

It is the lowest price for which any seller is willing to accept at a given time for the commodity futures contract.

Best Bid

The highest price that any buyer is willing to pay at a given time for the commodity futures contract

Carry:

The cost of financing (borrowing to buy) a position in financial instruments

Carry (Negative):-

It is a condition in which the cost of financing (the short-term rate of interest) is more than the return on the instrument.

Carry (Positive):-

It is a condition in which the cost of financing (the short-term rate of interest) is less than the return on the instrument.

Cost of Carry:The cost of carry of a commodity is the sum of all the costs including interest
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(financing costs), insurance, storage costs and other miscellaneous costs. Usually the price of a commodity future in the exchange is the spot prices plus cost of carry.

Market Order:-

An order for immediate execution; given to a broker to buy or sell at the best available price. Market order will be executed at the prevailing market price on the submission of such order.

Limit Order:-

A limit order enables you to specify the price below or above which the buy or sell trade will be executed.

Day Order:-

Orders that have time validity until the close of the days trading. If the order is not executed by the end of the day, the order is cancelled.

Good Till Date (GTD):-

It is the time validation of a buy or sell order for futures contracts submitted through the online trading system. The order is valid only until the end of the date specified at the time of placing the order.

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Good Till Cancelled (GTC):-

Good-till-cancelled order lasts till the order is executed or cancelled, regardless of how many days or weeks it takes. Investors often use GTC orders to set a limit price that is far away from the current market price. A GTC order is available for execution till the maturity of the contract, or till it is cancelled, whichever is earlier.

Margin:-

It is the security deposit given by the trading members to the exchange in order to deal in different contracts listed over there. The clients deposit this money with the members who in turn transfer it to the respective exchanges. The purpose of collecting margin money by the exchange is to avoid the counter party risk of defaulting by its members or their clients in fulfilling their obligations. It is part of the risk management system as prescribed by the market regulator, Forward Markets Commission (FMC).

Special Margin:-

"Special margin" is the additional margin imposed by the exchange to curb excess volatility in the market. Again, this varies from commodity to commodity.

Margin call:

A demand for additional funds to bring margin deposits up to initial levels.


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Mark-to-market:-

At the end of every trading day, the margin account of the trader / client is adjusted to reflect the participant's gain or loss. The price changes on the close of every trading day may result in some gain or loss as compared to the previous day's closing price. These price variations are netted into the daily margin account. This process is known as marking to the market.

Offset:-

Selling if one has bought or buying if one has sold a futures contract, thereby, taking an exact opposite position to the existing open position, thereby squaring off the position.

Spot Market:

Commodities are physically bought or sold usually on a negotiable basis resulting in immediate delivery.

Open Interest:-

Total number of futures contracts either on the long or short side that have not yet been offset or fulfilled by delivery. It is an indicator of the depth or liquidity of a market (the ability to buy or sell at or near a given price) and of the use of a market
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for risk and asset management. An increase or decrease in the open interest is also a direct indicator of the market's interest in trading the futures contract.

Pay-in of funds at the time of delivery:-

It refers to the transfer of funds from the buyer-member's settlement account to the exchange before he takes delivery of the commodity from the exchange specified warehouse.

Payout of funds at the time of delivery:-

It refers to the transfer of funds to the selling-member's settlement account from the exchange, after the buyer lifts the commodity.

3.2. SPREAD TRADING Overview:Spread trading is the simultaneous purchase of one commodity futures contract and sale of a different contract. The contracts can be different delivery months in same commodity, they can be two different commodities that are related or they can be same commodity traded in different locations.

For e.g. if a trader enters into a short position on the March 2000 Corn contract and simultaneously enters into a long position on the December 2000 Corn contract, he said to have entered into a spread, since he is simultaneously long and short in the

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market, on two related contracts (in this case the two contracts being of the same commodity).

Large commercial firms often use spread trading to reap maximum returns with minimal risk. As a simple example, commercial firms frequently use spreads to move their hedges from one contract month to another. They trade spreads in effort to recover their cost of storage and maintenance. They also examine spreads to determine where they will deliver particular commodity.

Generally only large speculators or commercial firms are found dealing with spread trading. Small speculators generally dont involve in spread trading because analyzing two positions simultaneously might be complex for them.

Fundamentalists will have to analyze relative demand and supply of two contracts rather than just overall demand and supply.

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Most analysis of spread trading uses fundamental analysis whether outright positions assumed by speculators use technical analysis.

Fundamental Analysis:-

It is detected primarily towards elucidation and analysis of supply and demand situation. The fundamentalist will look at such factors as planting, exports, crop production, domestic disappearance, weather and currency fluctuations.

Fundamental analysis seeks not only to discover the factors which go into determining current prices but to predict what those factors will be in future.

Technical Analysis:-

It can consider only those factors which the market place is itself composed of. The technician will look at factors like price action, volume and open interest to help in determining the opinion of the market. It is subdivided further into two parts:-

a). Descriptive Technician :- They assume that a market will continue for long enough time for making a profitable trade. b).Predictive Technician:They try to discover the technical factors that give

insight into futures of prices and is less concerned with marketplace as it exists.

3.3) Terminologies Involved with Spread

The spread consists of two legs: - the long contract and the short contract. Spreads can be between time/location/commodities.
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A spread between different contract months in the same commodity is called interdelivery or intra-commodity spread, while a spread between different commodities is called inter-commodity spread and examples of spread trading of a commodity in different market are inter-market spreads.

When one trades in spread, we are trying to capture the profit by change of differences in price of two different contracts. The spread trader is concerned with relative price levels of two contracts rather absolute price levels of both contracts. Let us consider following example of an intra-commodity spread:-

Suppose a trader on May 1, 1998 would have sold one December 98 copper contract at 73 cents and simultaneously bought a May 99 copper contract at 74 cents. So the difference in the price is 1 cent in favour of May contract. So the transaction book would look like:-

Date May 1, 1998

Action Taken Sell one Dec 98 copper contract for 73 cents Buy one May 99 copper contract for 74 cents

Now in Aug 6, 1998 the difference widens upto 3 cents (December 98 contract for 70 cents and 73 cents for May 99 contract). So the trader will liquidate his position by buying December 98 contract and selling May 99 contract.

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Date Aug 6, 1998

Action Taken Buy one Dec 98 copper contract for 70 cents Sell one May 99 copper contract for 73 cents

Supposing the trader was dealing with 25000 contracts, the net payoff will be as follows:3 cents gain on Dec 98 contract = 25000 *(73-70) cents = +$750 1 cent loss on May 99 contract = 250000*(73-74) cents = -$250

Say there was commission of 0.12 % on each contract, so net commission paid= $30+$30 = $ 60

Hence the total profit is equal to (750-250-60) = $ 440

The broker would be required to keep margin of around $250 for the trade, so the return would have been around 200 % in less than 3 months!!!!!

Intra-commodity spreads are divided into two parts:-

(i)

Bull Spread:-

The trader is long in the nearby month contract and short in deferred contract. An example would be going long on May 2011 copper contract and short on Dec 2011 contract. The trader expects the price will be stronger in nearby month and would go down as deferred contract approaches. So if prices are
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increasing/decreasing the trader expects price to increase/decrease more in the nearby month than deferred month.

(ii)

Bear Spread:-

The trader is short in nearby month contract and assumes long position in deferred contract. Going short on May 2011 copper and long on Dec 2011 would be a bear spread.

(iii)

Intercrop Spread:-

This entails taking a long position in one crop year and short position in another crop year. For example Kansas City wheat crop year starts with July contract and ends with following May contract. So a trader who is long in May 2011 wheat and short in July 2011 is an example of intercrop spread. However being long in July 2001 contract and short in May 2002 contract will not be an intercrop spread because they are in different crop years.

Quoting a Spread:Spreads are always quoted with long contract given first. Thus the trader will initiate long July wheat/short May wheat, not short May/long July wheat even though the short contract would be honoured first.

Inter Commodity Spreads:An inter-commodity spread is a spread between two different commodities. An example is Long Dec Gold/ Short Dec Silver. The commodities traded are related to each other.

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Both gold and silver in example are different commodities, but both are precious metals. Although this is not always the case, it is common to find the contract spreads are perfect substitutes for each other. It is the potential substitutability which gives two contracts a relationship that can be traded by a spread trader. If wheat can be fed to animals instead of corn, the price discount of wheat to corn will be limited.

Commodity Vs Product:A special type of inter-commodity spread is spread between a commodity and its products. The most common examples is spread between soybean and its products soybean oil and soybean meal.

Each bushel of soybeans weighing 60 pounds yields approximately 11 pounds of oil, 48 pounds of soybean meal and 1 pound of waste. Since oil is quoted in cents per pound, we just multiply the oil price by 11 to get value of bean oil in 1 bushel. To obtain the value of meal, we multiply the price of meal by 0.024 (48/2000 pounds in a ton).

A soybean crusher will make profit from difference between cost of buying the beans and the price of selling the products. This difference is called Gross Processing Margin (GPM) or the conversion margin. It is also commonly known as crush margin.

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The spread created by buying soybean futures and simultaneously selling soybean oil and meal futures is called crush spread. When one buys the oil and meal futures and short the soybean futures, it is called reverse-crush spread.

Butterfly Spreads:A butterfly spread can be viewed as two intra-commodity spreads combined. It is simultaneous purchase and sale of three contracts. An example would be:-Short 1 April Sugar contract Long 2 June Sugar contracts Short August Sugar contract

One should note that middle leg of the spread has two contract has two contracts whereas outside leg has only one. A butterfly spread is a low volatility spread due to its structure. The fact that it is both a bull spread ( long June / short Aug) and bear spread ( long June/ short April) leads to low volatility.

3.4) WHY TRADE SPREADS?

Lower Volatility:A significant advantage is usually lower volatility, hence lower risk. Generally speaking, spreads moves much less than outright positions. Generally a common move in wheat outright position is $5/day and for spreads it would be 0.25 cents/day. So they dont have to be monitored constantly as they are sedate

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enough. Through the use of spreads, even a small trader can participate in the market.

Limited Risk:Because of their hedged nature, the spread bears limited risk compared to outright positions.

Lesser Margin:The exchanges allow the trader to put up a much smaller amount of margin money because of their reduced volatility. This allows small traders to enter and to diversify the commodity portfolio which reduces traders risks further.

Locked Limit Days:The hedged nature of most spreads provides a protection against locked limit moves. Because of political action, weather, govt. reports or other factors, future prices can move pretty drastically. This can create locked limit days, where prices move their allowed daily limit and no trading takes place. This stops exposure to extreme losses which outright position holders would be exposed to.

More Attractive Risk/Reward Ratio:A spread may well provide a more attractive risk/reward ratio than outright position. For example the price of May/July wheat spread is largely determined by the carryover of soft red winter wheat. In the spring, the price of May wheat frequently is dominated by prospects for the new crop. This can create a situation where the outright price has discounted all known fundamentals and is trading in

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tight range while the May contract is gaining/losing substantially to July contract. The trade can then use spread position to cash in on the opportunity.

Useful to Outright traders:A sound knowledge of spreads or spread actions can be a powerful tool for outright position traders because it might signal the next move in the market. Floor Traders:Traders on the floor of the commodity exchange also gains several other advantages not available to general public. One of these is ability to keep no margin for spread position. Thus, these local traders will often trade new

crop/old crop spreads as a substitute for outright positions. This means traders need not have to come up with any money unless the trade is losing.

3.5) WHY SPREAD PRICES CHANGE?


Spread prices changes can be looked at as either random or non-random. A random price fluctuation is a price fluctuation that cannot be predicted. A fundamentalist using a model of sugar that predicts that the annual average sugar price, may believe that price fluctuations on a weekly or monthly basis are random; that is, they cannot be predicted. On the other hand, this fundamentalist will believe the annual price changes are not random because of his experience with his annual price model. Most traders cannot and dont try to predict what the price of commodity will be at closing time on a day. However, they trade on an assumption where the prices will be in a week or a month.

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A major theory of price behavior, random walk theory, contends that there is no relationship between prices from one day to next. In other words, a trader cannot predict tomorrows price looking at todays prices. This is sometimes called serial independence. This implies there is no such thing as seasonal or cyclical tendencies. This also means, technical analysis, which depends upon price action, has no grounding in fact. However, various empirical studies have shown that there are other forces than randomness in the market-place. A scalper is a professional trader or exchange member who provides same functions as a market maker or specialist on securities exchange, but trades only for his own account. They are responsible for maintaining narrower bid/ask spreads especially for less traded commodities.

For example it is very easy to get into/out of July/November soyabean spread; but its not the same with August/January spread. Here these spread scalpers will allow traders to enter/exit any spread in the same away because they are ready to take other side of the position.

The commercials or hedger will have maximum interest in spreads. They will actually own or use the commodity and hence look at spreads very carefully to determine their hedging and marketing strategies.

3.6) Why We Trade Futures Spreads


When it comes to Futures Spreads, many traders ask us what is the benefit of spreading futures contracts. They want to know why we often choose to spread futures contracts instead of either being long or short a single futures contract or option, or use option spreads instead. In our experience, futures spreads, also
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known as pairs trading, offers the leverage of futures contracts, helps hedge systemic risk, eliminates stops, and we get this reduced risk without having to pay up for time premium as options traders do. When you factor in opportunity available, risk management, cost effectiveness and margin efficiency, Futures Spread Trading can be a far superior strategy over flat priced futures trading, options and option spreads. Futures Spreads Defined Futures Spread Trading is a strategy of simultaneously buying a particular contract and selling a related contract against it. This strategy is also called pairs trading. In pairs trading, one market within a sector is bought and a separate market in the same sector is simultaneously sold short. This provides an investor with exposure to the relative performance of the two commodities with limited exposure to broader market and sector performance. For example, lets say you think the US is in the midst of a very strong and robust recovery and growth period. If that is true, then small cap equities will outperform large cap equities. Smaller companies can grow much faster than larger ones in percentage terms. A futures spread trader would see this as an opportunity to buy the Mini Russell 2000 and sell the Emini S&P 500. The Russell 2000 is a small cap index and the S&P 500 is a large cap index. In times of economic recovery and growth, small caps should outperform large caps. In times of economic recession large caps should outperform small caps.

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3.7) Benefits of Spread Trading


Trading spreads limits the exposure to systemic risk. In other words, it minimizes the risk associated with outside factors that can affect commodity prices. Lets take an example. Dec Corn is trading higher at $4.00 while July Corn is around $3.50. After studying the fundamentals and/or charts, you feel Dec Corn should drop 25 to 50 cents while July Corn will remain unchanged. You short Dec Corn. The next day the Fed announces it is bailing out Europe. Money floods the US and International financial system. The US Dollar Index plummets, and over the next month the USD decline sends Dec Corn higher to $5.00, July Corn higher to $4.50. If you had been short Dec Corn and long July Corn the spread would still be around 50 cents and you have time for Dec Corn/July Corn to narrow, which it certainly may do. If you were only short December Corn you lost $1. You may have been fundamentally correct, that Dec Corn was overvalued and should be sold. But since you did not long the July Corn, you lost money even though you were correct about the market fundamentals. The change in the value of the US Dollar turned the trade into a loser. We use pairs to eliminate as much systemic risk as possible. We want our trading to be about the relative value of two commodities or crops within the same market. We want to minimize the effect of outside market forces as much as possible.

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Hedging Systemic Risk: We trade futures spreads to hedge against systemic risk. You never know when the next shock to the system or market crash will happen. Weve learned throughout the years to never expose ourselves to more risk than necessary. When a trader in long one contract and short another, they are hedging out the USD. The USD represents the entire US economy. If we can hedge this out of our positions, we do so immediately. Lets say we are long the Crude Oil (CL). That means we are long CL but we had to put up cash margin to get that position. The CL contract is priced in USD. In that case, we are not just long the CL, we are also short the USD. If we used USD to get long CL, we have a long CL/short USD position, or a CL/USD cross. If Greece defaults on their bonds, sending the Euro into a tailspin, the USD will go up materially. The rising USD puts pressure on Crude Oil, sending CL down. The only way to offset this risk is to spread Crude Oil against a deferred contract or another market. Lets say July Crude is the front month. We are bullish Crude Oil and we buy July. To cancel out the USD we sell December Crude, creating a long July Crude, short Dec Crude spread. Why do we do this? If we are long July Crude, we are really long July Crude(CLN) and short USD, or CLN/USD. If we short December Crude (CLZ), we are really short December Crude and long USD, or USD/CLZ. When you combine the CLN/USD and USD/CLZ, you get a CLN/CLZ cross. The long USD and short USD cancel out.

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If some catastrophic even happens on the other side of the world, causing the USD to rally and CL to decline, my spread should be intact. Whatever amount July Crude decreases, most likely Dec Crude will go down to. The outside event will have been properly hedged. Leverage and Margin: Futures Spreads should reduce your margin, but more importantly, it will reduce the leverage you are using. When you are long the Emini S&P 500 overnight, you have overnight margin of $5625. When you are short the Emini DJIA, you have overnight margin of $6500. However, if you are long the ES and short the YM, the margin is not a combined $12,125. There is a spread margin credit and the total overnight margin is reduced to $2054. That is about 83% reduction. Why are margins reduced? Futures spreads are generally less volatile than being just long or short a single contract. The exchanges understand this and reduce the margin requirements. Futures spreads are generally less volatile because they narrow down the trading ideas and factors involved in the trade. When you are long the Emini S&P 500, you are not just long the S&P index. You also have exposure to the USD and the US financial system as a whole. This is massive exposure to events and conditions that are impossible to predict or account for. When you spread a contract, you are hedging out the USD, or outside market forces, and just making the trade about two very specific markets. There will be fewer factors and therefore fewer unknowns by hedging out the USD. This is another reason why the margins are reduced.

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The leverage traders are using in their accounts are also greatly reduced, which is a good thing. Most traders are over leverage their accounts. Overleveraged accounts either lead to traders blowing out their accounts on a big market move against them or slowly bleeding the account to $0 because they use stops that are too close to the normal trading range. Stops:Futures spreads do not have stops. They are not accepted at the exchange. Good news is you really dont need them if you are properly leveraged. It is one of our favorite aspects of futures spread trading. I cant stand it when an event half way across the globe sends the market down (or up) and it triggers a stop in one of my positions. I may be correct about the bullishness of Gold or Crude Oil, but a 5% decline in the Japanese Stock Market stops me out overnight, and then Gold or Crude goes up again.

The nice thing about futures spreads is they typically eliminate the outside market risks if the spreads are thought out and executed properly. In our experience, traders tend to put their stops within normal trading ranges. This makes the trader need to be exactly right in direction and timing for a trade, or they will be stopped out. Why do traders do this?

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Traders want to risk only X amount of money in a trade. If X amount of money is smaller than the daily trading range Y, then traders are too leveraged for the positions in their accounts. Either the traders need to use more capital per trade, or they can reduce their margin, leverage and risk by using futures spreads. If traders want to take a bullish position in the market, they can buy the front month and sell a deferred month. If they want to take a short position in the market, they can sell the front month and buy the deferred market. Markets to Spread: Any market can be spread traded. Some markets like the grains, livestock, energies, softs and financials are more common than the indices, currencies and metals. All markets can have calendar spreads or inter-commodity spreads. However, all markets might not have a spread discount. Spreading Corn vs. Wheat gets a 60% reductions in margin because they are related markets. Spreading Coffee vs. Cocoa has no margin reduction because the fundamentals of the two markets have nothing in common. If the markets are related

fundamentally, there is a good chance a spread credit exists. To find out if markets have spread credits just go to the Margin/Performance Bond section of the Exchange web site. 3.8) Historical Seasonality Many spread traders follow seasonal trends and patterns. Many futures markets have seasonal patterns. Crude Oil and RBOB Gasoline tend to increase during the summer while Heating Oil and Natural Gas tend to increase during the winter. The
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Grain markets are seasonally the highest in the spring and summer months and lowest right after harvest in the late fall. Traders follow these patterns and trade the seasonal channels. For example, this time of year the grain markets tend to go up faster in the old crop vs. the new crop. Traders will buy July corn and sell Dec Corn, or buy July Soybeans and sell Nov Soybeans. Any shortage in beans or concerns about the crops will cause the near months to rally faster than the deferred months. This seems to happen more often than not, which makes it a very popular spread trade.

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FUNDAMENTAL ANALYSIS & SPREAD TRADING OF CHICKPEA (CHANA)

1.1) OVERVIEW
Chickpea or chana is a very important pulse crop that grows as a seed of a plant called Cicerarietinum in the Leguminosae family. It contains 25 % proteins which is the maximum provided by any pulse and 60 % carbohydrates. It is placed 3rd in the importance list in the food legumes that are cultivated throughout the world. Chickpea (Cicer arietinum L.) is the largest produced food legume in South Asia. Chickpea is grown in more than 50 countries (89.7% area in Asia, 4.3% in Africa, 2.6% in Oceania, 2.9% in Americas and 0.4% in Europe). India is the largest chickpea producing country accounting for 70% of the global chickpea production. The other major chickpea producing countries include Pakistan, Turkey, Iran, Myanmar, Australia, Ethiopia, Canada, Mexico and Iraq

1.2.) IMPORTANCE
Chickpea is an important source of protein for millions of people in the developing countries, particularly in South Asia, who are largely vegetarian either by choice or because of economic reasons. In addition to having high protein content (20-22%), chickpea is rich in ber, minerals (phosphorus, calcium, magnesium, iron and zinc) and -carotene. Its lipid fraction is high in unsaturated fatty acids.
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Chickpea plays a signicant role in improving soil fertility by xing the atmospheric nitrogen. Chickpea meets 80% of its nitrogen (N) requirement from symbiotic nitrogen xation and can x up to 140 kg N ha-1from air. It leaves substantial amount of residual nitrogen for subsequent crops and adds plenty of organic matter to maintain and improve soil health and fertility. Because of its deep tap root system, chickpea can withstand drought conditions by extracting water from deeper layers in the soil prole. Chana is used as an edible seed and also used for making flour. There are mainly 2 types of chickpea produced i.e. Desi Type (Chickpeas with colored and thick seed coat) and Kabuli (they characterized by white or beige-colored seed with rams head shape, thin seed coat, smooth seed surface, white owers, and lack of anthocyanin pigmentation on the stem). Chana is usually suited for those areas having relatively cooler climatic conditions and low level of rainfall. It yields best when grown in sandy, loam soil having an appropriate drainage system, as this crop is very sensitive to excess water availability.

1.3.) CROP SEASONALITY


Chickpea is seeded in the months of September to November ( Rabi Season ) in India. The maturity period of desi type chickpea is 95 - 105 days and of kabuli type chickpea is 100 110 days. Harvesting of the plant is done when its leaves start drying and shedding. In India it is harvested in February, March & April.

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1.4.) PRODUCTION
India is the largest producer of chickpea followed by Pakistan, Turkey and Iran. India produces around 6 8 million tones and contributes around 70 % of worlds production. Chickpea is the most largely produced pulse crop in India accounting to a share of 40% of total pulse production.

Pulses Production in India

Others 11% Matar 7% Urad 7% Masur 9% Moong 9% Chana 40%

Tur 17%

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The domestic demand of Chickpea is so large that even after India being the largest producer of Chana it is also t the he largest importer in the world. India imports around 3 4 lakhs tones of chana. The countries which export Chickpea to India are Canada, Australia, Iran, Mayanmar, Tanzania, Pakistan & Turkey. Over four fifths of chana produced in the country is used t to o produce chana dal and over four fifths of this dal is ground to make flour termed as Basin.

World Chana Production Trends

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Chana Production(Lac Tons)


120

100

80

60 Production in India 40 Production in World

20

Statewise Chana Production


Karnataka 5% Andhra Pradesh 9% Maharastra 10% Madhya Pradesh 48% Rajasthan 12%

Uttar Pradesh 16%

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1.5.) MAJOR TRADING CENTRES

Madhya pradesh: Indore, Bhopal, Vidisha Maharashtra: Jalgoan, Lathur, Mumbai, Akola Rajasthan: Jaipur, Bikaner, Kota, Jodhpur, Sriganganagar, Hanumangarh Others: Delhi, Kanpur, Hapur, Jalandhar, Ludhiana

1.6.) EXPORTS IMPORTS

Being the largest producer and consumer of Chana, India also imports Chana from Australia, Canada, Turkey and Myanmar while it exports Kabuli Chana to U.S., U.K., Saudi Arabia & U.A.E. With the introduction of duty free import of pulses, Chana imports have been showing an increasing trend over the years.

1.7.) MARKET INFLUENCING FACTORS

Rainfall during monsoon season and soil moisture Weather factors during winter season (unseasonal rains may damage the crop) Area and production in major producing states like Madhya Pradesh, Maharashtra, Andhra Pradesh and Rajasthan Arrival pattern from February till April Demand from stockiest, mills and retail demand Government policies export/import, duties, stock limits and other restrictions Import of pulses and chana by Government and private agencies
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Output in Australia and Canada

1.8.) GOVERNMENT POLICIES

In the eleventh 5 Year plan (2007 12 ), government launched National Food Security Mission (NFSM) to ensure food security by producing adequate amount of pulses. In order to increase the area and production of pulses, a centrally sponsored National Pulses Development Program (NPDP) was launched in different states in mid 80s with financial aid of government of India. Various policies are aimed at improving the quality of seeds such as Production of breeder seeds, distribution of certified seeds, Purchase of breeder seeds of pulses from ICAR, Integrated pest management (IPM)s. Minimum support price is an important scheme from the central government to protect interest of farmers. If market price falls below MSP, then Government will come in to rescue the farmers. To bridge the supply demand gap in pulses the government has been increasing the MSP of all pulses. The % change of MSP for Chana over the years is around 19 %

Minimum Support Price of Chana(Rs/Quintal)


2011-2012 2009-10 2007-08 2005-06 2003-04 2001-02 1750 1730 1600 1445 1435 1425 1400 1200 1200 2100 2800

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2.) MONTHLY OVERVIEW OF CHANA

February, 2011
The produce of chana is expected to be 7.37 million tonnes as per the second advance estimate released by Ministry of Agriculture. The acreage under chana is expected to increase by 11.8% to 92.12 lakh hectares as on January 28, 2011 compared to the period in previous year. With increased arrivals i in n the mandis, the spot prices of chana were on a decline in the month. The near month futures prices of NCDEX chana contract and spot prices moved in tandem with convergence seen on the expiry of the February contract of chana.

Spot versus Near Month Futu Futures Price of Chana

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The volume in NCDEXs futures contracts of chana saw a monthon-month month increase of 19% from 4,108,570 MT in January 2011 to 5,080,980 MT in February 2011. The NCDEX chana contract which expired in February 2011 saw 11,960 MT of deliveries.

APRIL, 2011
Chana prices during the month of March stayed weak under supply pressure. The expectation of higher supplies in local mandis up to April has led to a downward pressure on the spot and futures prices alike. The arrivals in Akola, Maharashtra Ma started declining by end of March and picking up in Indore, Madhya Pradesh. The arrivals are expected to peak by end of April in Bikaner, Rajasthan. The arrival season for chana comes to an end by end of May.

Spot versus Near Month Futures Price of Chana

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June 2011
Chana prices in futures market trended upwards in May and June vis--vis vis April taking cues from the physical market where dwindling arrivals and strong demand amid the marriage season pushed the prices up. Arrival of this pulse starts in February while early June marks the end of major arrivals of this commodity. ommodity.

Spot versus Near Month Futures Price of Chana

August 2011
Chana prices showed signs of moderation in early August (Figure 3); however expectation of tight supplies in the c coming oming months has left prices at elevated
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levels. Chana prices dipped below ` 3,000 a quintal in the first half of the month, later climbing above ` 3,100. Futures prices of chana are indicating further rise in prices (Figure 5). NCDEX chana futures prices for September and December expiry are trading above ` 3,210 and ` 3,430 per quintal.

Supply of chana in domestic markets has dried up in domestic markets, while forthcoming festive season is expected to revive demand such that reliance on import is imminent. Australian export of chana is expected to rise marginally. As per trade sources, import contracts for Australian chana to be shipped between October and December have been sealed between A$650 675 a tones (approximately ` 3,120 `3,240 a quintal). Acreage under chana in Canada is expected to fall 48% from a year ago translating into lower produce. A blanket ban on export of food items from Tanzania has reduced availability of chana in the global markets

Reason for rise in price Chana prices are elevated in the absence of a cheap substitute. Yellow pea is viewed as the closest cheap substitute of chana, but short domestic supply due to damage to standing crop early this year by severe winter in Uttar Pradesh and dim outlook of future supply from Canada, the largest exporter of dry peas to India has left the pea prices soaring. Supply of dry peas from Canada is expected to fall on account of significantly low carry-in stocks and expected 27% fall in acreage. Canadas dry pea export is forecasted to decline 40%. The scenario is no better in the U.S., the second largest exporter, as acreage under dry pea has more than halved. Yellow pea prices exhibited mixed trend in August (Figure 4) as traders abstained from buying at record high prices. However expectation of low supply in
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the coming months averted correction in the prices. Yellow pea has been trading above ` 2,400 a quintal since last week July, almost ` 500 500-600 600 per quintal above the levels seen last year.

Spot versus Near Month Futures Price of Chana

FEBRUARY, ARY, 2012


Domestic production of chana is expected to be 7.66 million MT in 2011-12 2011 as against 8.22 million MT last year. Adverse weather in Andhra Pradesh, Rajasthan and Maharashtra is expected to damage the standing crop in these major producing states. Of the total chana produced in India, desi type contributes 80% of the total while the remaining in kabuli.

The expansion of irrigated farm land in northern India has led to displacement of chana by wheat in large areas over the last decades. Con Contrary trary to the development in
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the northern states, the southern states have experienced an increase in acreage under short duration varieties that could be grown in warmer environments. Andhra Pradesh, in particular, has outperformed other states by large scale sc adoption of improved seed varieties pushing the yield to 1.4 MT per hectare compared to the country average of 900 kg a hectare.

Chana is sown during October to December every year and harvested between February and May. The harvest season sees arriva arrivals ls coming into the mandis such that buyers enter the market to procure the commodity. The peak arrival season runs from March to May when arrivals hit various markets across the country starting from the mandis in southern states of Karnataka and Andhra Pradesh. adesh. Crop arrivals begin in Madhya Pradesh by March - April followed by Rajasthan in April - May.

Chana - Futures Price Movement

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Cold wave in Madhya Pradesh and Rajasthan may delay the harvesting of standing rabi pulses crop. Chana prices have been ruling firm on expectation of delay in arrival and decline in produce.

The near month price of chana remained below ` 3,400 a quintal during January and February 2012. However, prices were seen rising from ` 3,238 on February 1, 2012 to more than ` 3,700 a quintal by end of the month amid concern over short supply in the current season

EFFECT OF SUBSTITUTE (YELLOW PEA) IN CHANA PRICES

Yellow peas traded steady between `2,425 and ` 2,500 a quintal in January and February 2012. The acreage under peas in the current rabi season has reported to have increased in key states of Uttar Pradesh, Madhya Pradesh and Bihar. Agriwatch reported commencement of new crop arrival at Harpalpur, Madhya Pradesh. The fresh crop traded at lower rates of ` 1,850 a quintal due to lower quality. Yellow pea has become popular as a cheaper substitute to chana in the eastern part of India.

EXPORT IMPORT & INTERNATIONAL SCENARIO

Sowing of chana begins in April-May in Australia and Canada and ends in November. In India, crop year for chana begins around September and ends in May. As per Pulse Australias Australian Pulse Crop Forecast released in December 2011, total desi chana production is expected to be 367,900 MT while

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kabuli chana output is estimated at 58,600 MT in 2011. Above average yield combined with good demand from local splitters in Victoria is expected to drive interest in desi type of chana. Desi type chana fared better in the last season when wet conditions had damaged crop produce.

Production of dry peas in Canada is expected at 2.116 million MT in 2011-12 as against 3.108 million MT last year. Canadian export of dry peas is expected at 2.1 million MT in the current year. The pace of export of dry peas is reported to be only marginally lower that record set last year. Similar to chickpeas case, acreage under dry pea is estimated to rise 1.2 million hectares in 2012-13 from 0.9 million hectares this year spurred by comparatively higher returns from the crop. Consequently production and export are expected to increase to 2.650 million MT and 2.2 million MT in 2012-13.

JUNE 2012

Like any other agricultural crop, chana, experiences seasonal pattern in prices declining during peak arrival season and rising as arrivals dry up. However, this year chana prices have not strictly followed this seasonal pattern. Average prices per quintal declined from Rs 3,320 in November 2011 to Rs 3,144 in December 2011 in expectation of arrivals ahead of start of harvest. January and February saw prices rise to Rs 3,326 and Rs 3,564 later stabilising at Rs 3,580 per quintal in March 2012 in Delhi.

Firm tone in prices during the month of February and March could be attributed to delay in arrivals from Madhya Pradesh as cold wave had disrupted harvest. In the
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latter part of the arrival season which is dominated by arrivals from Rajasthan with Bikaner as the main trading centre saw prices rise from an average of Rs 3,617 in April to Rs 4,187 a quintal in May as arrivals dipped to a fraction of usual supply in the physical market

A primary sample survey conducted by NCDEX of the Bikaner district showed that chana yield had dipped by close to 30% due to inadequate winter rains, frost and a new menace rodents reducing the total produce of the region. Some farmers were also holding back their produce pulling the supplies down well into the peak arrival season from close to a total of 12,982 MT in May 2011 to 4,355 in May 2012 (Figure 4) in the mandi. In contrast, a similar survey of Indore and Devas districts in Madhya Pradesh showed that the produce of the region was sold out as reflected by stabilization of price in March

Of the total produce of chana, kabuli chana (dollar chana) production in India is forecasted to have jumped by 2-2.5 lakh MT to 6 lakh MT in 2011-12 with Madhya Pradesh leading the states. Subsequent higher arrival of kabuli in key mandi of Indore cooled price of kabuli during the arrival month of March. Monthly average price of kabuli chana declined from Rs 5,980 in February 2012 to Rs 5,778 in March 2012 (Figure 5) but soared above Rs 6,600 in April 2012 as arrivals dried up.

Limited arrival of yellow peas after March 2012 supported gains in price of the pulse. Prices of yellow pea, viewed as a cheaper substitute of chana, has been rising in tandem with price of chana through April and May.

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Spot versus Near Month Futures Price of Chana

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3)SPREAD TRENDS IN THE YEAR 2010


JANUVARY FEBRUARY 2010:

3000 2900 2800 2700 2600 2500 2400 2300 2200 10-Aug-09 150 100 50 0 -50 -100 -150 10-Aug-09 10-Sep-09 10-Oct-09 10-Nov-09 10-Dec-09 10-Jan-10 10-Feb-10 10-Sep-09 10-Oct-09 10-Nov-09 10-Dec-09 10-Jan-10 10-Feb-10 Jan 10 Close(Rs) Feb 10 Close(Rs)

price differential
Market Trends: Since the beginning of 2010, chana futures prices were on a bearish trend due to emergence of selling pressure on anticipation of rise in output in Rabi 2009-10 following higher acreage. The ban on export of pulses had been extended until March 2010.
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MARCH APRIL 2010:


3200 3000 2800 2600 March 10 Close(Rs) 2400 2200 2000 April 10 Close(Rs)

0 -20 -40 -60 -80 -100 -120

price differential
Market Trends: Chana futures prices held by Rs.16/Quintal as speculators indulged in profit booking and also due to increased supply from M.P. & Rajastan

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MAY - JUNE 2010


3000 2900 2800 2700 2600 2500 2400 2300 2200 2100 2000 May 10 Close(Rs) June 10 Close(Rs)

0 -20 -40 -60 -80 -100 -120

price differential

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JULY AUGUST 2010


2700 2600 2500 2400 2300 2200 2100 2000 July 10 Close(Rs) August 10 Close(Rs)

0 -10 -20 -30 -40 -50 -60 -70 -80 -90

price differential

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SEPTEMBER OCTOBER 2010


2600 2500 2400 2300 Sept 10 Close(Rs) 2200 2100 2000 Oct 10 Close(Rs)

0 -20 -40 -60 -80 -100 -120

price differential

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NOVEMBER DECEMBER 2010


2700 2600 2500 2400 Nov 10 Close(Rs) 2300 2200 2100 2000 10-Jun-10 0 -20 -40 -60 -80 -100 -120 10-Jun-10 10-Jul-10 10-Aug-10 10-Sep-10 10-Oct-10 10-Nov-10 10-Dec-10 10-Jul-10 10-Aug-10 10-Sep-10 10-Oct-10 10-Nov-10 10-Dec-10 Dec 10 Close(Rs)

price differential
MARKET TRENDS Chana futures slipped on estimates of higher outputs but higher government support prices and hopes of a pick up in local demand restricted the fall.

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SPREAD TRENDS IN THE YEAR 2010

150

100

Jan - Feb 50 Feb - March March - April April - May May - June 0 1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97 101 105 109 113 June - July July - Aug Aug - Sept Sept - Oct -50 Oct - Nov Nov - Dec

-100

-150

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4)SPREAD TRENDS IN THE YEAR 2011


JANUVARY - FEBRUARY 2011:
2800 2700 2600 2500 Jan11 Close(Rs) 2400 2300 2200 Feb11 Close(Rs)

80 60 40 20 0 -20 -40 -60 -80 10-Aug-10 10-Sep-10 10-Oct-10

price differential

10-Nov-10

10-Dec-10

10-Jan-11

10-Feb-11

MARKET TRENDS Owing to a delay in new crop reaching the market chana prices surged by 8 %
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Crops in Australia destroyed due to floods further pushing up the price

MARCH APRIL 2011


2900 2800 2700 2600 2500 2400 2300 2200 11-Oct-10 11-Nov-10 11-Dec-10 11-Jan-11 11-Feb-11 11-Mar-11 11-Apr-11 March11 Close(Rs) April11 Close(Rs)

40 20 0 -20 -40 -60 -80 -100 -120 -140 11-Oct-10 11-Nov-10 11-Dec-10 11-Jan-11 11-Feb-11 11-Mar-11 11-Apr-11

price differential
MARKET TRENDS Chana futures witnessed mixed trends with marriage season demand and rising prices of substitutes supportive while expectations of fresh arrivals in market reduced gains.
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MAY JUNE 2011


3100 3000 2900 2800 2700 2600 2500 2400 2300 2200 10-Dec-10 10-Jan-11 10-Feb-11 10-Mar-11 10-Apr-11 10-May-11 10-Jun-11 May 11 Close(Rs) June 11 Close(Rs)

0 -20 -40 -60 -80 -100 10-Dec-10 10-Jan-11 10-Feb-11 10-Mar-11 10-Apr-11 price differential 10-May-11 10-Jun-11

Market Trend: Chana prices rose by Rs 13 to Rs 2,738 per quintal in futures trading as speculators created fresh positions driven by firming spot market trend.

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JULY AUGUST 2011


3200 3100 3000 2900 2800 2700 2600 2500 2400 10-Feb-11 10-Mar-11 10-Apr-11 10-May-11 10-Jun-11 10-Jul-11 10-Aug-11 Jul11 Close(Rs) Aug11 Close(Rs)

0 -20 -40 -60 -80 -100 -120 10-Feb-11 10-Mar-11 10-Apr-11 10-May-11 10-Jun-11 10-Jul-11 10-Aug-11

price differential

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SEPTEMBER OCTOBER 2011


3900 3700 3500 3300 3100 2900 2700 2500 11-Apr-11 0 -20 -40 -60 -80 -100 -120 11-Apr-11 11-May-11 11-Jun-11 11-Jul-11 11-Aug-11 11-Sep-11 11-Oct-11 11-May-11 11-Jun-11 11-Jul-11 11-Aug-11 11-Sep-11 11-Oct-11 Sep11 Close(Rs) Oct11 Close(Rs)

price differential
Market Trend: Chana spot market crashed due to weak market sentiments caused by the imposition of stock holding limit on Chana. Similarly, the futures prices too nosedived after the exchanges were asked by the Forward Markets Commission (FMC) to impose a special margin of 10% on long side of all running contracts of chana from 30th September 2011.

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NOVEMBER DECEMBER 2011


4100 3900 3700 3500 Nov11 Close(Rs) 3300 Dec11 Close(Rs) 3100 2900 2700 10-Jun-11 0 10-Jul-11 10-Aug-11 10-Sep-11 10-Oct-11 10-Nov-11 10-Dec-11

-50

-100

-150 10-Jun-11 10-Jul-11 10-Aug-11 10-Sep-11 10-Oct-11 10-Nov-11 10-Dec-11

price differential

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SPREAD TRENDS IN THE YEAR 2011


150

100

50 Jan - Feb Feb - March March - April 0 1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97 101 105 109 113 April - May May - June June - July July - Aug -50 Aug - sept Sept - Oct Oct - Nov Nov - Dec -100

-150

-200

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CONCLUSION
In the year 2011 Chana prices scaled to test new high after a consolidation phase of more than 3 years. Prices at the futures are heading towards its annual gain of around 28%. During April 2011 the arrivals pressurized prices and we saw a seasonal low at Rs.2198/qtl. There after the prices surged to Rs.3700/qtl towards September end as seasonal demand gained momentum for the festivals.

The rally in prices is attributed to fall in domestic production amid increase in domestic consumption and lower imports due to lower output in Australia. We estimated Indian production to be slightly lower by 1.2% at 73.6 lakh tons. The production in Australia was pegged lower by 44% to 3.1 lakh tons and the domestic consumption rose by a CAGR of 6.65% over last decade. Rise in domestic consumption is the result of increase in standard of living and growth in the countrys economy in recent years.

For the season 201112 the government has increased the MSP for Chana by Rs.700/qtl or 33.3% to Rs.2800/qtl in order to boost the domestic production. The rise in MSP coupled with higher realization this year has encouraged the farmers to cover large area under cultivation. For 201112 as per government of Indias latest reports the production is estimated lower at 7.5 million tons as compared to last seasons record output of 8.25 million ton. The consumption is expected increase by around 45% as compared to last years consumption of 7.9 million tons. Internationally the production in Australia is expected to be better from last year at
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3.94 lakh tons however still lower that the normal years. This year as well chana prices are expected to follow last years price movement. Prices during January and February will be determined by the development in weather and festive demand. Thereafter we expect the prices to trade weak till the month of April as the new crop arrival hits the spot markets. And subsequently the price is expected to bounce and breach last years levels during the month of August and September.

In a nutshell we expect chana prices to trade weak till April 2012 and test 24502500 on the lower side and thereafter recover to test Rs.39504000 by last week of September 2012. Overall we expect the year to be bullish for Chana.

Formulating the Trading Plan

Identify the spread This is the most important part of the trading plan. It is also the most time consuming part. It starts with the analysis of historical data of the price movements of the commodity(s) upon which a trader wishes to initiate a spread. Once a recurring pattern has been identified, the fundamentals of the pattern thus identified needs to be analysed. This enables to the trader to get a good idea about the underlying variables which affect the spread price movement. This is important as merely following the pattern without understanding the reasons behind it can lead to extreme losses for the trader, as the underlying fundamentals might have changed and thus might not follow the pattern, and worse might even go against the pattern.

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FUNDAMENTAL ANALYSIS & SPREAD TRADING OF CHANA COMMODITY

Identify the entry and exit points

Once a spread pattern has been analysed, the chart analysis of the spread is done to identify the appropriate entry and exit points. In identifying the points of entry and exit the following constraints have to be kept in mind The no. and the extent of drawdowns between the two points have to be kept to a minimum and if possible at nil. The profit potential of entering the spread at the chosen points should be sufficiently large. It is better to place the trigger points, at least the entry point, on a certain date, the date being arrived at after a chart analysis of the historical data and taking into account the above constraints also. As this would be hassle free and the trader need not be overtly bothered about the daily price movements. Of course it is not necessary that the point be defined by the date alone. If there exist case wherein the price movement of the spread itself shows a definite pattern, the point can be defined on the basis of the spread price itself.

Decide the type of order and place the order Though there are many types of orders, each suited to a specific situation; it is generally 2 types of orders would be most suitable in this context

Best buy order In the case where the entry point has been defined on the basis of a date, it would be best to execute a best buy order on the specific date; since the system would execute the order at the best possible price it can get and not wait till the tick reached a certain price level.
Abhinav Narula (PGDMB12/01) 89

FUNDAMENTAL ANALYSIS & SPREAD TRADING OF CHANA COMMODITY

Market order In the case where the entry point is defined on the basis of the spread price, it would be best to execute a market order, as this order will not get executed till the tick on the two contracts reach a certain price. Complete the execution of the spread by squaring off the position once the exit point has been reached.

Throughout the trading plan the emphasis on the entry point, but it is equally important to know when to exit. Though, in general, the entry and exit points of a spread need not be as accurate as when taking an outright position, it still needs to be of some reasonable accuracy. Similar to the entry point the exit point can also be defined in terms of a specific date or in terms of the price of the spread and accordingly either a market order or a best buy order can be placed. But the main difference is that the trader though need not see every tick on the market should be aware of the spread price changes and also be able to anticipate and act quickly on any large price changes, either favorable or unfavorable.

Abhinav Narula (PGDMB12/01)

90

FUNDAMENTAL ANALYSIS & SPREAD TRADING OF CHANA COMMODITY

REFERENCES

1. www.pj commodityventures.com 2. Futures Spread Trading- Courtney Smith 3. www.ncdex.com 4. www.commoditycontrol.com 5. www.bloomberg.com 6. www.rbi.org.in 7. Yahoo Finance 8. www.bseindia.com 9. www.nseindia.com 10.www.mcxindia.com 11.Spread Trading Howard Abell 12.www.investopedia.com

Abhinav Narula (PGDMB12/01)

91