Derivatives are not bad. Bad players make them sound bad. A commodities exchange is very welcome at the NSE. It will promote price stabilization for most if not all commodities. here are a few insights about futures trading....
futures are contracts for future delivery of a product. They explicitly define the quantity, quality, price per unit, date of delivery, method of delivery as well as the buyer and seller.
Futures contracts are highly leveraged. i.e you only need a small investment (initial margin) to enter into a contract. This initial margin, usually less than 10% of the value of the contract, must be deposited in your trading account, and is adjusted daily to reflect market activity.
The 2 parties involved are the seller (holds a short position)and the buyer (holds a long position).
the two main characters in the game are HEDGERS & SPECULATORS.
Hedgers either own (eg. a farmer) or seek to own (eg. a manufacturer)a commodity.
The farmer in Kericho wishes to fetch the highest price possible for his next harvest and therefore enters in to a contract with Unga LTD to sell 1000 sacks of maize at KSH 1,000 a sack. Unga agrees to it because they don't wish to risk waiting until next harvest just in case the price of a sack of maize shoots up to KSH 1,100. This secures Unga LTD the lowest possible price.
Before the date of contract maturation (expiration), if the price of a sack of maize goes up to 1,100, Unga gains 100 & farmer looses 100 and vice versa. Gains & loses are debited or credited in their respective accounts.
Either party can close their positions at any time before contract date. Farmer can always sell to the market at market prices and vice versa for Unga.
The speculators are people who seek to make a profit from fluctuating prices. A speculator taking a short position will sell a contract at a higher price, hoping the prices will fall and make a profit from buying the same contract at a lower price. A speculator taking a long position will buy a contract low hoping to make a profit by selling it high.
The genius of it is the hedge against risks of price fluctuations. Just imagine the benefits that would come out of this in a high inflation environment.
A MAN FOREWARNED IS A MAN FOREARMED