Futures Trade

Introduction

The two important factors which influence farm income are weather and market prices.  While the former affects farm income through its impact on production, productivity and quality of the product, the latter affects farm income through price fluctuations.  The risk arising from vagaries in weather conditions is sought to be partly compensated by the new insurance tools, although they are quite inadequate to give sufficient relief to the farmers who sustain crop losses.

On the other hand, public procurement at minimum support price (MSP) is made to protect the farmers from falling farm prices.  However, due to methodological issues in MSP fixation and inadequacies in the procurement system, this has not succeeded to the desired level.  The role of futures trade assumes significance in this context as a tool for price stabilisation and risk aversion.  It offers opportunity to the farmers to get higher price for their produce and the economic losses through appropriate operations in the futures market.

Futures contract involves an agreement to buy or sell a product at a prefixed price at a future date.  The buyer agrees to buy the product at the agreed rate on a future date and the seller agrees to deliver the specified quantity at the agreed rate.  The delivery and the settlement of contract may be done towards to end of the contract period.

The futures market needs to be distinguished from the “ready market”.  In the “ready market”, the exchange of the product and the price takes place for every transaction.  Once the product is brought to the market, the farmer is constrained to sell the product at the price prevailing in the market or quoted for the product in the market.  In the “ready market” there are a number of intermediaries between the farmer and the ultimate consumer.  This results in the exploitation of the farmers as they could realise only a small fraction of the consumer’s rupee.

On the other hand, in the futures market, transfer of product takes place at the end of the contracted period.  Moreover, it is a trade contract directly entered by the buyer and the seller without any intermediaries.  However, the futures trade is facilitated by the service provider by offering the online trading platform.  The farmer can enter into a foreward contract for the sale of his product to a trader, processor or exporter without actually delivering the product till the end of the contract period.  They are entering into a contract for buying and selling a specified quality of a product at an agreed price at a specified future date.

But the period of foreward contract varies with different agricultural products.  While the contract period is 6 months for pepper, it is four months for cardamom and rubber.  Since the purchase and sale are affected in the foreward market without the product actually changing hands, it provides ample scope for speculation, especially when the total futures trade turnover in an agricultural commodity exceeds 10 to 20 times the actual production of the product.  Therefore, in the absence of proper safeguards, this may result in undue rise in the prices or alternatively a crash in price.  Hence, the Foreward Markets Commission has been established as the statutory body to supervise the operations of the foreward markets to bring stability in prices and transparency in their operations.  The FMC has built up regulatory measures to prevent undue speculation and extreme volatility in futures prices.

Last Updated : 04-01-2008