Purpose of the Futures Market

Futures market is expected to help the market participants through two vital economic functions, viz., Price Discovery and Price Risk Management. At the macro level, the liquid and vibrant futures market having nationwide participation also assists in sobering down inter-seasonal and intra-seasonal price fluctuations. This not only helps in bringing about reasonable stability in the prices of commodities, but also supports farmers to get remunerative prices without adversely affecting interests of consumers. Such a market also provides a market-based alternative to government involvement like procurement at Minimum Support Price and Public Distribution System.

Price discovery made in spot markets – sometimes also called as cash market -, which are mostly fragmented over-the-counter markets, is inefficient. Price discovery in spot market is affected by geographical dispersion, differential needs of the buyers and sellers in terms of quality, quantity, place of delivery and difficulties associated with handling physical delivery, absence of option to settle the contract by payment of price-difference. In any case, the spot market does not meet the need for price-forecast felt by participants in the physical markets. 

With convergence of bids and offers emanating from a large number of buyers and sellers from different parts of the country – and possibly from abroad - futures trading is a very efficient means of forecasting the price for a commodity. Convergence of bids and offers in a single order book at NMCE, is facilitated by the DTSS software provided by CMC.

Price Risk Management is very closely related to Hedging, which means transfer of some or all of that risk to those who are willing to accept it, which are in turn called Speculators. Price risk is managed by taking opposite positions on the two legs of the market e.g. spot and futures. The futures prices are linked to the spot prices through carrying cost, which comprises cost of storage, interest, wastage, shrinkage etc. Therefore, the two prices tend to move in parity. Taking opposite positions in the two legs of the market therefore tends to offsets loss in any market on account of adverse price fluctuation. All the participants in the physical markets, like, producers, processors, manufacturers, importers, exporters and bulk consumers can focus on their core activities by covering their price-risk in futures market. Their operations become more competitive since the price-risk involved in procurements, supply is transferred to the futures market.

TOP