Gold (Part 1)
India has two commodity exchanges: the Multi Commodity Exchange (MCX) and National Commodity and Derivative Exchange (NCDEX). Each has its specialisation: MCX is widely recognised for its metals and energy commodities, while NCDEX is predominantly known for agri commodities. Nonetheless, there has been a surge in trading of agri commodities on the MCX. In upcoming chapters, I will be looking at the different commodities traded on the exchanges and helping you become familiar with their contracts.
We’ll look into each item that’s actively traded on the commodity exchanges. Our objective is to understand the contract details, decide which one to trade and identify the influencing factors. We won’t cover the standard overview of commodities markets – history, futures, American farmers, Chicago Mercantile Exchange etc. You can find that in any commodity market material. Instead, I’d like to head straight for the core of it by chopping up the contracts and related specifics.
This list of commodities on the MCX is accessible from their website.
The aim is to encompass the key products that can be bought and sold. To properly grasp how ‘Derivative Futures’ operate, it is essential to comprehend Commodities first.
MCX Gold is heavily traded, making up an average 15,000 contracts per day. This translates to an Indian Rupee value of over 4500 Crore, just for one contract type, commonly referred to as “Big Gold”.
There are several versions of Gold available for trading, which can occasionally make it confusing for both novice and experienced commodity traders to decide which one to trade. To provide a better understanding, here is a list of all the various kinds of Gold contracts –
All these variations are derived from Gold. The optimal way to understand their distinctions is to comprehend the contractual stipulations of each. Let us begin with ‘The Gold’.
Let me start by indicating the main points of the contract requirements set by MCX. We can take a deeper look into each item individually afterwards.
We’ll discuss the details in sequence so it’s easier to comprehend the agreements. To begin, let’s look at the price quotation.
The quotation is for a 10 gram Gold purchase, which already takes into account all import duties and taxes. We can discuss this further later on if needed. Here is a snapshot of the last traded price of gold futures on MCX –
As you can see, the last traded price of Gold is Rs.31,331/-. Do note; this is the quote for 10 grams of gold. Since the lot size is 1 Kg (1000 Grams), we can calculate the contract value –
(1000 * 31331) / 10
The margin amount required is Rs.1,25,868/-, which means the margin percentage is roughly –
1,25,868 / 31,33,100
As evident, the margin percentage is nearly 4%, similar to other currency contracts. Unfortunately, the Rupee value of the margin is substantially high, obstructing many retail traders from initiating positions in Gold. That said, contracts like Gold Mini and Gold Petal come with a lower placed Rupee value on its margins, which we will discuss later in detail.
Assuming you purchase 1 lot of Gold on MCX, you need to invest around Rs.1.25 lakhs as margin. Every tick in the market will result in either a gain or loss of Rs.100 – this is relatively simple to understand.
P&L per tick = (Lot Size / Quotation) * Tick Size
Let us apply this on Gold –
= (1000 Grams / 10 Grams) * 1 Rupee
= 100 Rupees
This formula can be used for any futures and options contract to determine the P&L per tick. Let’s go over an example of this with the JPY INR contract. It has a lot size of 100000 JPY, and the quotation was for 100 JPY with a tick size of 0.0025. So, based on these figures, we can calculate the P&L per tick –
= 2.5 Rupees
Let us now focus on expiry. Gold contracts are available every 2 months and each stay in the system for a year, giving you 6 to choose from at any point. To illustrate, the following table should provide an idea of how this works – as of August 2016. The expiry information states the 5th day of the contract month for Gold.
It goes without saying that the most recent contract (October 2016) is the easiest to trade. Upon expiration of said contract on October 5th, 2016, the September 2017 will be introduced and December 2016 will become the most heavily traded contract.
Remember that for equity trades, payment is by cash and not physically. On the other hand, for commodities settlement is physical and delivery mandatory. Thus if you own 10 lots of gold, upon choosing the delivery option you will receive 10 kg of gold. The intention to do so must be made before four days from expiry – this means that if your contract expires on the 5th, then it has to be done on or before the 4th (1st, 2nd, 3rd or 4th).
You only need to know a few things about the Gold contract to trade it. All that is essential for you to understand before entering the market is comprehended in this knowledge.
Now, let’s take a look at the various types of gold available to trade through exchanges.
The hefty margin requirement in Rupee value for the large gold contract limits many traders from participating in its trade, which is likely why exchanges have offered contracts with smaller stipulations.
The other gold contracts that are available to trade is –
o Gold Mini
o Gold Guinea
o Gold Petal
The details for the other gold contracts are as follows –
Now that we have already discussed the details, the table should be easier to understand. Let us now delve into the corresponding margins.
As you can see, Gold Mini (GoldM) contract requires a margin of Rs.15,682/-. In terms of percentage –
= Margin / Contract Value
Contract Value = (Price * Lot size)/Price Quotation
= (31365 * 100)/10
In terms of margin percentage, this is roughly the same as big Gold. For the sake of completeness let us quickly calculate the P&L per tick for Gold Mini. We know –
P&L per tick = (Lot Size / Quotation) * Tick Size
= Rs.10/- per tick.
In addition to Gold Mini, there are Gold Guinea and Gold Petal contracts. Both offer shallow margins of Rs.1251 (Gold Guinea) and Rs.154 (Gold Petal). The lot sizes are small, consequently making the contract value smaller than that of other variants like Gold Petal (Delhi) and Gold Guinea (Ahmadabad). If you want to trade gold, I advise against these variants.
Here is my honest opinion – if you are trading Gold stick to either the Big Gold contract or the Gold Mini contract, simply because the liquidity is quite bad in all the other contracts. To give you a perspective on liquidity on a regular trading day (on MCX) –
o 12 – 13K lots of big gold contracts get traded
o 14-15K lots of Gold mini contracts get traded
o 1-1.5K lots of Gold Guinea contracts get traded
o 8-9K lots of Gold Petal contracts get traded
Although the amount of lots in Gold Petal might be tempting, do not let it fool you; the lot size is merely 8 grams, which would equate to 8-9K lots or around 2-2.5 Crs.
Note that liquidity is highest in the closest month contract. Therefore, it’s best to stick with that. As a general rule, liquidity decreases further away from the expiration date.
Now we will move on to further topics relating to Gold – parity in domestic and International contracts, factors which impact the commodity, and the interplay of gold, equities, and the US dollar.