A futures contract is a legal agreement to buy or sell an item at an agreed price on a future date. Recognised futures contracts are standardised in nature and can be for commodities or financial instruments. Gold is among the commodities that are traded through futures contracts in the form of exchange-traded, formal agreements.
Gold has been bought and sold for centuries in physical forms like coins, bars, and jewellery. Over the years, gold trading has evolved to incorporate forms like gold exchange-traded funds, gold bonds, digital gold, to name a few. Investors who operate in the futures market are broadly speculators or hedgers. Speculators take the market risk with the hope of making a profit, while hedgers invest in futures contracts to manage the risk of adverse price movements. Whatever the purpose, futures trading can be efficiently done only by investors with sound knowledge of the financial and commodities market. Knowledge not only helps them to manage the market risk but also understand the costs and features of the futures contract.
Various aspects of gold futures in India
Gold futures can be traded on the Multi Commodity Exchange (MCX) in India. Gold futures trading is an investment in gold without physically holding the metal. The purpose of the gold futures investors is not in the possession of or investment in gold. They use gold price and its movement as a medium to hedge their risks.
Types of gold futures: Gold futures trading in MCX takes place in a variety of lot sizes. The size of the lot decides your transaction value. Apart from Gold of the 1 kg lot size, there are gold mini, gold petal and gold guinea contracts which can be entered into in futures trading in India. A mini contract is of 100 grams, guinea is of 8 grams while petal is of 1 gram. However, the 1 kg gold is the most popularly traded and therefore, most liquid.
The gold futures contract: Gold futures are available in MCX as per the contract launch calendar. MCX gold contracts are presently launched every two months, with an expiry of 12 months. The contract starts on the 16th day of the launch month and can be traded up to the 5th day of the expiry month. The gold quotation is provided for 10 grams, where the trading unit is 1 kg, and the maximum order size can be 10 kg.
Settlement procedure: In a gold futures contract, the settlement of the contract takes place on the 5th of every month. You can either settle the contract (take delivery of the physical gold) or square off your position before the 1st of the month. If you choose to settle the contract it will be in the form of numbered gold bars with 995 purity.
Margin: While the actual margin may fluctuate all the time, the initial margin in the February 2022 gold contract was set at 6% or SPAN margin, whichever is higher. So, if you have a Rs 1 lakh position in a futures contract, the margin payment will be Rs 6,000. The exposure of Rs 1 lakh by paying only Rs 6,000 means the possibility of greater profitability. If you settle the contract, you will have to pay the full value of the underlying gold, including taxes as applicable.
The physical gold: The physical gold in the MCX gold futures contracts is certified for purity by London Bullion Merchant Association-certified refineries. MMTC-PAMP is one such LMBA certified refinery in India. The gold, including coins, can be held in an electronic format in the MCX’s clearing corporation’s COMRIS system. All gold delivered or held has an individual assay certificate and a mentioned making charge. Such electronically held gold can be easily traded and liquidated.
Understanding futures contracts through an example:
- Let us say you enter a gold futures contract now. If the last traded price of gold is Rs. 50,000 per 10 grams, your contract value for 1 mini lot will be Rs. 50 lakhs.
- The MCX tick size or minimum price movement is Rs 1/per gram. So, in this contract, you will gain or lose Rs 100 with an increase or decrease in each rupee. This will be your profit or loss from the contract.
What’s the process of trading in gold futures?
- To start with, you need to open a commodity trading account with a broker registered with MCX. The account opening requires the filling up of a form and furnishing basic KYC documents such as proof of identity and residence, passport size photo, bank details etc.
- Once your account is open, you have to deposit the margin money in a margin account with the broker. You will find the margin rate in the Gold Futures contract document. If your initial margin gets reduced due to trading losses, you will have to deposit a maintenance margin. It is the sum that is required to be paid to maintain the initial margin.
Once you transfer this money, you can log in and trade in gold futures from Monday to Friday between 9 am and 1130 pm.
The gold futures investor is expected to have a strong understanding of gold investments, the economy’s influence on it and the gold trading ecosystem. Since futures contracts rank high up in terms of risk as well as reward, a thorough understanding of the aforementioned aspects is highly recommended.