Since soy oil traded in India is constituted by both- the domestically produced and the imported oil soy oil, its prices are influenced equally by the supply-demand factors influencing both- the international and domestic markets. Hence a soy oil importer in India is exposed to various sources of price fluctuation in the market at any given point of time, which makes his business ‘risky’. Futures trading can help minimise such a market-induced risk. Let us understand with an illustration.
An importer of crude soy oil could be a trader who simply buys soy oil from the physical markets in Argentina/Brazil/USA (via. Forward dealing) and sells to large refiners in India. Or he could be refiner who in turn sells to several wholesale/retail traders or pack and sell under a local or national brand.
In order to remain in business (in either of the case), he has to buy regularly from Argentina/Brazil/USA through a one/two/three month forward contract. Consider he contracts to buy 2000 tons for soy oil from the physical market in Argentina (equivalent to Rs 642 at Indian port after duty) during July for delivery by a month’s time. If the prices soy oil (refined) dip to Rs 638 by the end of the delivery period, say August, you have the risk of incurring a loss of Rs 400/ton of the contracted quantity. Such a risk could be minimised by participating in futures trading of soy oil in India. For this, all that a importer has to do is to enter into a futures contract (of relevant month, in this case the August ’13 contract) at the Exchange by taking a short (sell) position at today’s prevailing futures price for soy oil, say Rs 640/10 kg for quantities equivalent to that contracted for physical delivery. In case the prices dip as illustrated above, you could minimise your potential loss by selling your futures contract at the Exchange at that day’s futures price of Rs 637/10 kg. This is called Hedging. Futures trading serves as the most effective hedging tool for a soy oil importer.
The above illustration (do not reflect actual market price as on date) could be better understood with the following matrix:-
|20th July 2013|
|Buy forward contract @ Rs 642||Take Short (sell) position at Rs 640|
|20th August 2013|
|Prices fall to Rs 638||Close your Sell position @ Rs 637|
|Profit/loss – Rs 4||+ Rs 3|
|Net loss – Rs 1|
By hedging in futures, you have minimised your loss to Re 1/10 kg or Rs 100/10 kg instead of Rs 400/10 kg. In case, you had not done so, you had the risk of incurring the loss to the extent of Rs 400/10 kg.
An importer could also protect his soy oil inventory through similar kind of hedging using futures contract in soy oil.
Such an opportunity exists in Indian edible oil market owing to the fact that country is the producer of almost all types of oilseeds, all of which have a consumer market as ‘edible oils’ and hence are substitutable in nature. This is further supported by the fact that Indian edible oil market is highly price sensitive or elastic in nature and the prices of the substitutable oils move mostly in single direction. In such a scenario of close correlation between the substitutable sources, there exists a clear trading opportunity for the interlinked constituents. A trader in groundnut /sunflower /rapeseed /coconut /palm oil (a close competitor to soy oil in Indian and international market) could hedge his risk associated with his business using the soy oil futures.
As a trader, his business involves stocking and selling to potential clients at a profitable price over a long period of time either through a forward dealing or spot transaction. Hedging through futures helps in protecting the value of his oil inventory and the risk associated with making a forward commitment to his clients.
Not only those associated directly with edible oils, but the Oilseed Growers (soybean and other oilseed growers) and Traders and Solvent Extractors could benefit substantially from soy oil futures, one among the prime driver of Indian edible oil prices. Since Oilseed Growers are sellers in the market, they could minimise the risk of potential adverse change in oilseed prices by taking a long (buy) position at the Exchange. When the oilseed prices swing adversely, the probable loss could be off-set by closing the long position they hold.
|30th June 2004|
|Anticipate a price of Rs 30000/ton of soybean and take up sowing on a particular acreage||Take short (sell) position at Rs 29700/quintal|
|25th September 2004|
|Prices fall to Rs 30300/quintal||Close your long position @ Rs 29300/quintal|
|– Rs 700/quintal||+ Rs 400/quintal|
|Net loss||– Rs 300 (instead of Rs 700/quintal loss in the absence of futures).|
Similarly, a grower of any other oilseed viz. Groundnut/Sunflower/Rapeseed and others could hedge using soy oil futures by exposing to an equivalent quantity (based on the value of the commodity being hedged as against soy oil futures.
Traders in any oilseed or Solvent Extractors, who are at the buying end of oilseeds or semi-processed product of oilseed, could hedge their risk by taking a short (sell) position of soy oil futures contract.