1. COTTON PRICE RISK MANAGEMENT
MCX IPF PRESENTATION
COTTON PRICE RISK MANAGEMENT

2. Type Of Commodity Market
There are different type of Commodity Market:
Spot Market: bought & sold for cash and the delivery takes place immediately. Physical contracts for cotton are not standardized and specific to each transaction (volume, quality, location, etc).
2) Forward Market: The trading takes place directly between the buyer & seller. Terms such as Qty,
Quality, Delivery date and price and negotiated between buyer & Seller (two person only).
3) Futures Trading: Future trading in commodities results in transparent and fair price discovery
due to the large scale participation from all entities associated with the value chains involved.
Future market/ financial markets have uniformed standard contracts:
1) Delivery location/place, 2) Delivery procedures, 3) Quantity (Lot size), 4) Quality (like length, mic, moisture, trash, grade) and 6) Price etc
Did you Know?
The first organized futures market – Bombay Cotton Trade Association was started in Trading in certain commodities was stopped in 1960’s and 1970’s and resumed only in

3. What is Commodity Exchange
In simple terms, a commodity exchange is a market place where different commodities are traded.
Commodities are traded in standardized contracts of different maturities call futures contract
It is regulated by SEBI
Exchange has no role in pricing of contracts
Buyers and sellers determine the price.
In future markets, one trader’s gain is another’s loss (Zero Sum Game)
What is the need of Commodity Futures Exchange ?
A future exchange provides future price signals .
In the absence of price signals, one has access only to current prices.
a) he can not plan for the future and
b) policy makers would not be able to prepare for future plan.
Price Discovery
Price Risk Management/Hedging.

4. COMMODITY DERIVATIVES EXCHANGE
present commodity exchange ECOSYSTEM
COMMODITY DERIVATIVES EXCHANGE
VAULTS
CCRL

5. Permitted Commodities Commodities traded at MCX
Active Commodities on national Exchanges & Commodities traded at MCX
, Chana
Permitted Commodities
Precious Metals
Metals
Energy & Others
Agri *
Total
SEBI Notified 4 11 12 64 91
Listed at
MCX 2 5 6 15
NCDEX, NMCE & ICEX 1 - 14
* Agri includes Cereals, Pulses, Oilseeds, Oil cakes, Spices, Fibres, Sweeteners, Plantation, Dry fruits & other non-farmer linked agri commodities
Commodities traded at MCX

6. MCX in Indian Market EXTENSIVE REACH ( As on March 31, 2018)
668 Members
52,497 Authorized Persons
1,211 cities / towns across India
Market share of %
MCX: MARKET SHARE IN KEY SEGMENTS FOR FY17-18
AVERAGE DAILY VOLUME – Single Side (INR Crore)*
Commodity Segment
MCX Market Share in Indian Commodity Derivatives
Proportion of MCX’s turnover
Precious Metals & Stones
99.84%
25.33%
Energy
100%
33.30%
Base Metals
39.24%
Agri- Commodities
15.46%
2.12%
* Option trading in gold contracts commenced on 17th October, 2017

7. Price Risk Management (Hedging)
Price risk management is very important and essential for market participants, such as farmers, ginners, traders, exporters, spinners and textile companies etc.
The importance of risk management cannot be overstated; an expert committee set up by Government of India found that commodity derivative exchanges are efficiently fulfilling their functions of price discovery and price risk management.
The Concept of Hedging:
Hedging is the process of reducing or controlling risk. It involves, taking equal and opposite positions in two different markets (such as physical and futures market), with the objective of minimising or reducing risks associated with price changes.
It is a two step process, where a gain or loss in the physical position due to changes in price will be offset by changes in the value on the futures platform, thereby reducing or limiting risks associated with unpredictable changes in price.
Reducing risk may not always improve earnings, but failure to manage risk will have direct repercussion on the risk bearers long term income.
Finally, the purpose of HEDGING is to REDUCE price uncertainty and the impact of adverse Cotton price movements. It can enhance credit worthiness, ability to borrow and improve stability in profits.

8. Hedging Illustration ( Falling Prices)
Scenario 1: Assume a ginner is holding stocks of 1000 bales of cotton (29mm) in February. By hedging, he can lock in the price for his stock in February itself and protect himself against the possibility of falling prices. The spot price of cotton today is Rs 19,000/bale and the price of April 2019 futures contract is Rs a bale.
The ginner sells (short) 40 lots of April 2019 contract in February (today) at Rs 20,000 for a delivery in April He deposits and pays only 5% of the contract value as initial margin to the exchange for entering a position in the futures market.
Assume the prices fall in April Rs 500 a bale. The ginner sells his stock in physical Rs 20,000 a bale and takes an opposite position in the futures market, by buying 40 lots of April 2019 futures contract at Rs 20,500 a bale (square off).
Time
Cash
Futures
Today
Spot market at Rs 20,000 a bale
Sells 40 lots (1 lot = 25 bales) of April 2019 at Rs. 20,500 a bale
February 2019
Sells 1,000 bales of cotton at Rs. 19,500 a bale
Buys 40 lots of April 2019 at Rs. 20,000 a bale
Result
Loss of Rs. 500 a bale
Gain of Rs. 500 a bale
Thus, ginners/traders/stockists/ hedged himself from the falling prices.

9. Hedging Illustration ( Rising Prices)
Hedging Strategy for Buyers (Exporters, Spinners, Traders):
Buyers can buy their requirement of the years in a futures contract by paying a margin of only 5% and lock their prices for the entire year. They can keep on procuring cotton in the physical market round the year and square off the corresponding position in futures. Thus, even if the cotton prices goes up, they don’t incur any loss, because the profit from furfures market offsets their increased cost of procurement.
Example: Suppose that today (in the month of February), an exporter receives an order to export 1000 bales of cotton in April. He is planning to buy cotton from spot market and export it in April. Assume, today’s spot prices is Rs 20,000 a bale and April contract trading at 21,000 and he is worried that prices would rise by April. By hedging, he can lock in the purchase price in February itself (today), and protect himself from rise in prices in the spot market.
He can exit before expiry of the contract (square off). Exporter buy from the physical Rs. 21,000 a bale (loss of Rs 1000/bale) and sell (short) 40 lots of April 2019 contract at Rs. 22,000 a bale (gains Rs 1000/bale).
Time
Cash
Futures
Today
Spot market at Rs 20,000 a bale
Buy 40 lots (1 lot = 25 bales) of April 2019 at Rs. 21,000 a bale
February 2019
Buy 1,000 bales of cotton at Rs. 21,000 a bale
Sell 40 lots of April 2019 at Rs. 22,000 a bale
Result
Loss of Rs a bale
Gain of Rs a bale
Thus, exporter hedged himself from the rising prices in the cash market.

10. Impact of Commodity Futures - Synopsis of Evaluation Studies
Impact Assessment Study of Cardamom Futures Trading - IIM Kozhikode (2014): Planter may be better off by selling his output in a futures exchange since, the chances of getting a better price for their high quality output is better.
Study by Deloitte India (2013): Commodity futures market directly generates employment for around 1.5 million personnel in India – 0.93% of India’s service sector labor force
The Nielsen Company (2013): Assessing the Impact of Dabba Trading on Commodity markets in India – The Dabba Market (trades outside the regulated markets) is more than 3 times of the trading through regulated Exchanges
IIM Calcutta and NISTADS, New Delhi (2012): Mentha Oil futures facilitated rise of India as major exporter of processed mentha crystals – transitioning from raw material exports.
Tata Institute of Social Sciences (2012): Futures platform has ensured stable and fair prices for the SMEs. Fairer prices reduce the cost of production and import bill, boost growth of the SMEs and provide accurate demand-supply signals that reduce risks in SMEs.
UNCTAD (2009): Number of intermediaries in Mentha value chain has reduced after introduction of futures market, reducing the price spread in the marketing channel from 11-12% to %. In case of Cardamom, it has helped to stabilize prices in the spot market.
IIM Lucknow (2007): Potato and Mentha Oil markets showed substantial improvements in increased price realization to farmers during the period after the introduction of futures.

11. Fund based Arbitragers (Cash & Carry)
COTTON VALUE CHAIN, participation reach & MCX Cotton Snapshot
Approximate Indian market size : ₹ 68,000 crs
Annualized price volatility in : 19.3% & Exposure to price risk: More than ₹ 13,000 crs
At MCX
Delivery for more than 7 lakh bales
80% correlation with ICE prices
Contract specifications covers more than 75% of cotton grown in India
The market operational both morning and evening - price discovery when global markets are active
Exempted from paying Commodities Transaction Tax
Value Chain
Ginners
Exporters
Brokers / Traders
Millers
Financial Players
Retail & HNI
Jobbers
Spreaders
Other financial
Fund based Arbitragers (Cash & Carry)

12. Price Volatility, Correlation with international market & spot-futures convergence
Efficient price discovery depends on Exchange mechanism for spot-futures price convergence through physical delivery mechanism

13. MCX Cotton Month Wise Volume and Interest

14. 29 MM Cotton Contract Specification
Parameter
Specification
Price Quote
Rs./ Bale
Trading Unit
25 Bales
Tick Size
Rs. 10
Contract Months
Monthly - Oct to Aug
Expiry Date
Last trading day of month
Delivery Unit
100 Bales
Delivery Logic
Compulsory Delivery
Maximum Allowable Open Position
At Client level - 3,60,000 bales
At Member level - 36,00,000 bales or 15% of the market wide open position whichever is higher.
For Near Month Delivery:
At Client level: 90,000 bales.
At Member level - 9,00,000 bales or 15% of the market wide open position whichever is higher.
STAPLE LENGTH (mm)
< 28.00
Rejects
28.00 to 28.50
2% Discount
28.50 to 29.50
No Premium / Discount
29.50 to 30.50
Premium 1%
> to 31.50
Premium 2%
TRASH
2%<= Trash <3.5%
Premium
Of 1
0.5
Basis
3.5%
> 3.5 to 5%
Discount 1:1
> 5%
Rejected
MOISTURE
Basis
8.5%
Accept upto 9.5%
1:1 Discount
Above 9.5%
Rejected
MICRONAIRE
< 3.5
Rejects
3.5
0.3% Discount
3.6 to 4.8
No Premium / Discount
4.9
> 4.9
COLOR GRADE
Up to 31-3
No Premium / Discount
41-3
3% Discount
42-3
5% Discount
STRENGTH
Minimum 28 Gtex

15. Calculation (Indicative) for Farmers / Traders
Kapas Price
50₹ / Kg
Approximately 500 kg of Kapas required for making 1 bale cotton (170 kg lint)
50,000 Kg Kapas Price (to make 100 bale cotton)
(54*500*100) = 27,00,000₹
Ginning Charge (Charge to convert raw Kapas to bale cotton)
800₹ / bale
Ginning Charge for 100 bale
(800*100) = 80,000₹
Total Cost (Kapas + Ginning charge)
(27,00, ,000) = 27,80,000₹
Cotton bale Price
24,000₹ / bale
Cotton bale cost for 100 bale
(24,000*100) = 24,00,000₹
Cotton Seed Price
20₹ / kg
Cost of Seeds out of 50,000 Kg Kapas*
(50,000*0.64*20) = 6,40,000₹
Total Value (Cotton bale + Cotton Seed)
(24,00, ,40,000) = 30,40,000₹
Profit (Total Value – Total Cost)
(30,40,000 – 27,80,000) = 2,60,000₹
*Assumption (Outturn=34%, Seed = 64%, Wastage=2%)

16. Delivery Procedures Delivery Location Rajkot Mundra Kadi Yavatmal
WSPs (Yamada, Origo, Navjyoti Logistic and Shubham Logistic)
Cotton Delivery
Weight Measurement
Moisture Testing
Samples Drawn
(5 Bales)
STACKING
Goods Deposited
WH Receipts Issued
Exchange Accredited WH
Lab Testing
(5 Samples)
LAB (WAKEFIELD)
Delivery Location
Rajkot
Mundra
Kadi
Yavatmal
Jalna
Adilabad
Warangal
Approximate cost for giving delivery of 100 bales
₹ /100 bale
Sampling & Assayer 's charges (per 100 bale)
Rs. 3,000 – 3,500 (excluding tax)
Unloading & Stacking at Warehouse ₹22/bale approx.
Rs. 2,200
Warehouse ₹2 / bale / day
200 / day
Standard Deduction
0.35% – 0.75% (based on month of deposit)

17. Month-Wise Delivery & Stocks
Month-wise Delivery of cotton at MCX Platform
Expiry date
Qty (Bales)
October 31, 2017
0.00
November 30, 2017
11,300
December 29, 2017
30,900
January 31, 2018
27,700
February 28, 2018
29,100
March 29, 2018
12,900
April 30, 2018
16,200
May 31, 2018
14,900
June 29, 2018
14,700
July 31, 2018
24,600
Total (October 2017 to July 2018)
1,82,300
October 31, 2018
1,300
November 30, 2018
8,100
December 31, 2018
24,400
January 31, 2019
38,500
Stocks as on February 06, 2019
Stock eligible for Exchange Delivery
1,06,200
Stock in process for delivery
22,700
Capacity of warehouse
2,61,500

18. Financial Institution
CCRL (CDSL Commodity Repository Ltd.)
CCRL
WSP/ Vaults
CCL
Client (Seller)
Client (Buyer)
Pledger
Assayer
Financial Institution
Issue Electronic WR & Confirm withdrawal / revalidation / stock confirmation for pledge
Creating masters, Entities, Clearing & Settlement activities
Pledge / un-pledge, invoke activities
Accept / Cancel Transfer Requests
Initiate request for deposits, Revalidate, withdraw, transfer, Pay In
Sampling & Testing / Grading activities
Receipt Pledging
In Progress 18

19. HOW CAN YOU PARTICIPATE ON MCX
Choose the Member Broker
Fulfill KYC at Broker level
Arrange for minimum initial margin requirement
Update yourself on Mark-to-Margin requirements
Know MCX regulations and byelaws
Select the commodity/ product to trade
Read the Dos and Don’ts
Know and distinguish among:
Brokerage and Transaction Charges
Margins, Taxation and Stamp Duty
Default Penalties and Arbitration

20. THANK YOU Multi Commodity Exchange of India Ltd.
Exchange Square, Suren Road, Chakala, Andheri East, Mumbai
Ph. –
The Contents do not constitute professional advice or provision of any kind of services and should not be relied upon as such. MCX does not make any recommendation and assumes no responsibility towards any investments / trading in commodities or commodity futures done based on the information given in the website and any such investment / trade are subject to investment / commercial risks for which MCX shall not be responsible. If financial, investment or any other professional advice is required, please seek advice of competent professionals.