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Thursday, August 7, 2008

Benefits of Commodity Derivatives for investors

Futures contract in the commodities market, similar to equity derivatives segment, will facilitate the activities of speculation, hedging and arbitrage to all class of investors.

Speculation:

It facilitates speculation by providing opportunity to people, although not involved with the commodity, to trade on the views in the movement of commodity prices. The speculative position is taken with a small margin amount that is paid to the exchange, and the contract can be squared-off anytime during the trading hours.

Hedging:

For the people associated with the commodities the futures market can provide an effective hedging mechanism against price movements.

For example an oil-seed farmer may go short in oil-seed futures, thus 'locking' his sale price and in the process hedging against any adverse price movements. On the other hand a processor of oil seeds may buy oil-seed futures and thus assure him a supply of oil-seeds at a pre-determined price. Similarly the oil-seed processor may go short in oil futures, which may be bought by a wholesaler of oil.

Also, there is a saying that 'Gold shines when everything fails'. Thus, gold can be used as a hedging tool against other investments.

Arbitrage:

Traders may exploit arbitrage opportunities that arise on account of different prices between the two exchanges or between different maturities in the same underlying.

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