Commodity Futures and Commodity Forwards

Commodity Futures are standardized contracts traded on recognised exchanges such as MCX, NCDEX, and NCX. Each contract specifies the commodity, quantity, quality, delivery month, and settlement mechanism. Because they are exchange‑traded, futures enjoy daily mark‑to‑market, a clearing‑house guarantee, and transparent price discovery.

Commodity Forwards are bespoke, over‑the‑counter (OTC) agreements between two parties to buy or sell a commodity at a pre‑agreed price on a future date. The terms—quantity, grade, delivery location, and settlement—are fully negotiable, making forwards flexible but exposing parties to counter‑party risk.

For the NISM exam, remember that futures are regulated by SEBI and must conform to exchange‑defined contract specifications, whereas forwards are governed by the Indian Contract Act and are not listed on any exchange. Questions often test your ability to identify which contract type a scenario describes based on these traits.

When you enter a futures position, you post an initial margin with the clearing corporation. This margin acts as a performance bond and is a fraction (typically 5‑15%) of the contract's notional value. Each trading day, profit or loss is computed against the previous day's settlement price, and the margin account is adjusted accordingly (mark‑to‑market).

Because futures are standardized, contract sizes are fixed (e.g., 1 kg of gold, 1 metric tonne of crude oil). The exchange also defines the tick size (minimum price movement) and the daily price limits to curb extreme volatility. These specifications are immutable for a given contract month.

Exam questions may present a scenario with margin requirements or daily price limits. Watch out for the phrase “initial margin” versus “maintenance margin” – the latter is the minimum balance that must be maintained; falling below it triggers a margin call.

The theoretical futures price reflects the cost of carrying (or holding) the underlying commodity until the contract's expiry. The cost‑of‑carry model incorporates the risk‑free interest rate (r), storage cost (s), any insurance or handling cost (u), and the convenience yield (y) that owners receive from holding the physical commodity.

Mathematically, the model is expressed as:
F = S \times (1 + r + u + s - y)^{T} where S is the spot price and T is the time to maturity in years. The exponent captures compounding over the holding period. A higher convenience yield (e.g., for scarce commodities) reduces the futures price, while higher storage or financing costs raise it.

In the NISM exam, you will often be given the spot price, the annualised rates, and the time to expiry, and asked to compute the fair futures price. Remember to convert percentages to decimals before substitution, and to use the same time basis for all rates.

A commodity forward is a private agreement between a buyer and a seller to exchange a specified quantity of a commodity at a predetermined price on a future date. Since the contract is customised, parties can tailor the delivery location, quality specifications, and settlement method to suit their operational needs.

Unlike futures, forwards do not require daily margining. The full contractual exposure is realised only at maturity, which means the parties must assess credit risk carefully. In India, forward contracts are commonly used by large manufacturers, exporters, and agricultural producers to lock in input or output prices.

For the exam, note that forwards are not listed on any exchange, lack a clearing house, and therefore are subject to counter‑party risk. Questions may ask you to identify why a forward is preferred for a bespoke transaction or why a futures contract is chosen for liquidity.

Futures contracts on Indian exchanges can be settled either by physical delivery of the commodity or by cash settlement, depending on the contract specifications. Physical delivery follows the exchange’s delivery rules, which include a notice period, quality verification, and a designated delivery point.

Cash‑settled futures calculate the final settlement price based on the spot price of the commodity on the last trading day. The profit or loss is credited or debited to the trader’s margin account, eliminating the need for actual movement of goods.

Forwards are usually settled by physical delivery, but cash settlement is also permissible if both parties agree. The settlement date is fixed in the contract, and there is no daily price adjustment. The exam may test you on the distinction between "final settlement price" for futures and "delivery price" for forwards.

SEBI regulates commodity futures under the "Commodity Derivatives Regulations, 2019". Key requirements include mandatory registration of brokers, daily reporting of positions, and a minimum net‑worth for participants. The exchange’s clearing corporation enforces margin norms and conducts mark‑to‑market.

Forwards, being OTC instruments, are not directly overseen by SEBI but must comply with the Indian Contract Act, 1872, and the Companies Act, 2013 for corporate participants. The Reserve Bank of India (RBI) may intervene if foreign exchange exposure is involved.

Exam questions often ask which regulator governs a particular contract type or what disclosure is mandatory for futures positions. Remember: SEBI → futures; no specific regulator → forwards (subject to general contract law).