What is the importance and types of commodity derivatives?

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A commodity can be defined as a product or a material that can be sold and bought. Commodity market and commodity derivatives market in general have existed in India for over 100 years. Commodity tips are widely taken by many traders who trades in commodities. Among top five producers of commodities, India is the one who produces most of the commodities and also a major consumer of bullion and energy products.

About 22% is contributed by agriculture to GDP of Indian economy. Agriculture performs a very significant role in achieving a GDP growth of about 8-10%. It is very regrettable that the market is suppressed due to the policies of FMC during the most of 1950s to 1980s. However, it was supposed to encourage to grow with times. Other economies of the world would want to avoid this kind of circumstances because it was a mistake. Moreover, it is not done in India alone those derivatives were doubted to much speculation, which will lead to damage the healthy growth of markets and farmers.

It is very important to understand that, why commodity derivatives are necessary and the role they can play in risk management. The prices of commodities, metals, shares and currencies fluctuate over time and it is generally known by everyone who trade.

Two important types of commodity derivatives.

Commodity futures contracts: A contract of buying and selling a commodity for a predefined delivery price at a specific future time is termed as futures contract. Futures contracts are standardized agreements that are traded on futures exchanges. The futures exchanges ensures the performance of contracts and also eliminates the default risk. Chicago Board of Trade (CBOT) was established in 1848, and along with it the commodity futures has been existed. It was done in the view to bring farmers and merchants together. There are various functions of futures markets but the main function is to transfer price risk from hedgers to speculators.

Commodity options contracts: Like hedges options are also financial instruments, which are used for speculation and hedging. The commodity option holder has the right and he don’t have the obligation to buy or sell a specific quantity of a commodity at a particular price on or before a specified date. This involves two parties one is the seller of the options who writes the option in the favor of the holder i.e, buyer, who pays certain amount to the seller as the price of the option. Buyer is the second party who is involved in this. Commodity options are of two kinds, first one is a “call” option which gives the holder a right to buy a commodity at an agreed price and the other one is “put” option which gives the holder a right to sell a commodity at an agreed price on or before a predeclared date which is also called expiry date.

Commodity market has great importance in the world’s economy. Huge number of traders prefer trading commodities. Hence, the market has become a very competitive place. If you wish to enter into the market then you must have complete knowledge about it. A stock market advisory can also help you to gain the overview of market and this will also provide you with some investment ideas for better earning.

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