Futures trading another lucrative business option for market players

Futures trading in castorseed has been going on for a very long time in this country. In this context it would be best to understand futures trading taking castorseed contracts as an example.

Example connected with futures trading in castorseed:
1) XYZ mill sells castor oil in the export market for the December shipment at Rs 100 per kilo.
2) Their cost sheet is as follows :
Sale price Rs 100
Cost of castorseed Rs 60
Present spot price)
Labour Rs 20
Overheads Rs 10
Profit Rs 10
3) They are unable to find a castorseed supplier who would offer them the required quantity for the December delivery.
4) They therefore hedge their castor cost bybuying in the futures market the required quantity at a price of Rs 61 per kilo.
5) Spot price of castorseed moves up to Rs. 80/- per kilo by December.
6) XYZ mill buys physical castorseed in the spot market at Rs. 80/- per kilo and settles or sells in the futures market at the price of Rs. 81/- per kilo.
7) Thus their cost sheet would now be as follows:
Sale price Rs 100
Cost of castorseed Rs 80
(Present Spot price)
Labour Rs 20
Overheads Rs 10
Loss Rs 10
Add: Profit on futures Rs 20
Net Profit Rs 10
8) Due to hedging in the Futures market the profit of the mill remains intact.

Case II : This illustration can be directly connected with how a farmer takes a decision regarding which crop is to be cultivated on his field in the current season.

1) A farmer wishes to make a decision on sowing of a crop in June.
2) He finds that the prevailing future prices for cotton at Rs 61 per kilo gives him the best returns for his investment whencompared to the prices (Futures) of other commodities for December delivery. (December is the month he expects to harvest his crop).
3) He decides to sow cotton.
4)To ensure that he is not affected by fluctuations in the price he hedges himself by selling an equivalent quantity of cotton in the futures market for December delivery at Rs 61. 5)It is known that in the long run kapas (raw cotton) prices will always move parallel to cotton prices. *6) Thus in the case of a price decline in the cotton market the farmer squares off his futures position and makes a profit and sells his produce in the spot market in December. He loses in terms of lower realisation for his kapas but makes up by the profit that he earns on the futures market.

(The author is a leading commodity trader and operates through his firm Prophecy Investments, Mumbai)