Futures contracts perform two important functions of price discovery and price risk management with reference to the given commodity. It is useful to all segments of economy. It is useful to producer because he can get an idea of the price likely to prevail at a future point of time and therefore can decide between various competing commodities, the best that suits him.
Futures trading enables the consumer get an idea of the price at which the commodity would be available at a future point of time. He can do proper costing and also cover his purchases by making forward contracts. The futures trading is very useful to the exporters as it provides an advance indication of the price likely to prevail and thereby help the exporter in quoting a realistic price and thereby secure export contract in a competitive market. Having entered into an export contract, it enables him to hedge his risk by operating in futures market.
Other benefits of futures trading are:
(i) Price stabilization-in times of violent price fluctuations - this mechanism dampens the peaks and lifts up the valleys i.e. the amplititude of price variation is reduced.
(ii) Leads to integrated price structure throughout the country.
(iii) Facilitates lengthy and complex, production and manufacturing activities.
(iv) Helps balance in supply and demand position throughout the year.
(v) Encourages competition and acts as a price barometer to farmers and other trade functionaries.
Futures trading is also capable of being misused by unscrupulous speculators. In order to safeguard against uncontrolled speculation certain regulatory measures are introduced from time to time.
They are:
Limit on open position of an individual operator to prevent over trading;
Limit on price fluctuation (daily/weekly) to prevent abrupt upswing or downswing in prices;
Special margin deposits to be collected on outstanding purchases or sales to curb excessive speculative activity through financial restraints;
Minimum/maximum prices to be prescribed to prevent future prices from falling below the levels that are un remunerative and from rising above the levels not warranted by genuine supply and demand factors.
During shortages, extreme steps like skipping trading in certain deliveries of the contract, closing the markets for a specified period and even closing out the contract to overcome emergency situations are taken.
Prospects
With the gradual withdrawal of the government from various sectors in the post-liberalization era, the need has been felt that various operators in the commodities market be provided with a mechanism to hedge and transfer their risks. India's obligation under WTO to open agriculture sector to world trade would require futures trade in a wide variety of primary commodities and their products to enable diverse market functionaries to cope with the price volatility prevailing in the world markets.
