Commodity Futures: Margin, Settlement & Delivery

What Is a Commodity Futures Contract? Structure and Specifications

Every commodity futures contract traded on MCX or NCDEX is defined by a detailed contract specification published by the exchange. Understanding these specifications is the starting point for anyone entering the commodity markets.

The first element is the underlying commodity itself. Contracts are grouped broadly into bullion (gold, silver), energy (crude oil, natural gas), base metals (copper, zinc, aluminium, lead, nickel), and agricultural commodities (cotton, chana, soybean, castor seed, guar seed, and many more). Each commodity has unique characteristics that the contract specification must address.

The second element is the lot size (also called contract size). Unlike the equity derivatives market, where lot sizes vary by stock, commodity lot sizes are fixed by the exchange and calibrated to reflect both market convention and practical trading requirements. On MCX, for instance, the standard gold futures contract has a lot size of 1 kg, the silver contract is 30 kg, and crude oil contracts are typically 100 barrels. Mini and micro variants exist for some commodities - a gold mini contract is 100 grams and a gold petal contract is 1 gram - enabling participation from traders with smaller capital.

The third element is price quotation. Gold is quoted in rupees per 10 grams, crude oil in rupees per barrel, copper in rupees per kg. The price tick (minimum price movement) and the value of each tick are also specified. For a 100-barrel crude oil contract with a tick size of Re 1 per barrel, each one-rupee move in price means a gain or loss of Rs 100 on one lot.

The fourth element is the contract expiry cycle. Most commodity futures contracts on MCX expire monthly or bi-monthly. The last trading day is typically a few days before month-end, with the precise date published well in advance. Traders who do not wish to take or give delivery must square off their positions before this date. Agri-contracts on NCDEX may follow seasonal cycles aligned with crop harvesting patterns.

The fifth element is the delivery specification. For physically settled contracts, the exchange specifies approved delivery centres (warehouses or vaults), quality standards (purity for gold, grade for agricultural produce), and packaging requirements. For cash-settled contracts, the settlement price is determined by a reference rate, often a poll-based or internationally linked benchmark published by the exchange.

Understanding contract specifications matters because every rupee of profit, loss, and margin requirement flows from them. Before trading any new commodity, download the contract specification document from the exchange website and read it carefully. The specifications may also change periodically - SEBI or the exchange may revise lot sizes, margins, or delivery centres - so always verify you have the latest version.

Types of Participants in the Commodity Futures Market

The commodity futures market serves a diverse ecosystem of participants, each with different motivations, risk appetites, and time horizons. SEBI broadly classifies commodity derivatives participants into hedgers, speculators, and arbitrageurs, with each group playing an important functional role in maintaining a liquid and efficient market.

Hedgers are the original reason commodity futures exist. A hedger holds a position in the physical commodity and uses futures to manage price risk. Consider a textile mill in Surat that has signed a six-month contract to supply cotton yarn at a fixed price. If raw cotton prices rise sharply, the mill's input costs surge while revenues remain fixed. By buying cotton futures on NCDEX today, the mill locks in the purchase price for raw cotton. If spot cotton prices rise, the loss in physical procurement is offset by a gain on the futures position. Similarly, a gold jewellery manufacturer in Ahmedabad holding large gold inventory may sell gold futures on MCX to hedge against a potential price fall.

Important nuances in hedging: hedges are rarely perfect because the futures price may not move exactly in line with the local spot price (this divergence is called basis risk), and the hedge must be actively managed as expiry approaches.

Farmers and farmer producer organisations (FPOs) are another class of hedgers who can use NCDEX futures to lock in crop prices before harvest. Though adoption among Indian farmers remains limited due to awareness and access constraints, SEBI and the government have taken steps over the years to broaden participation.

Speculators take on the risk that hedgers wish to shed. They have no underlying physical position; they participate purely to profit from anticipated price movements. A trader in Chennai who believes crude oil will rise because of supply disruptions in the Middle East may buy crude futures on MCX. If the price rises, the trader profits; if it falls, the trader suffers a loss. Speculators provide liquidity to the market, making it easier for hedgers to enter and exit positions at fair prices. Without speculators, bid-ask spreads would widen and market efficiency would suffer.

Arbitrageurs exploit price discrepancies between related markets - for example, between the MCX gold price and the London Bullion Market Association (LBMA) spot price adjusted for import duties, or between near-month and far-month futures contracts on the same exchange. Arbitrage activity ties prices together across markets and time periods, contributing to price discovery.

Institutional participants - commodity trading advisers, portfolio managers with SEBI commodity derivatives registration, and proprietary trading desks of brokers - bring sophistication and scale to the market. Their presence generally improves market depth but can also increase volatility during stressed periods.

Retail investors increasingly participate as speculators, often focusing on liquid contracts in gold, silver, crude oil, and copper. SEBI has put in place position limits for various categories of participants to prevent excessive concentration and market manipulation. Being aware of these limits is important, especially if you trade actively or in large sizes.

Margin in Commodity Futures: Initial, Exposure, and Additional Margins

Margin is the single most important concept in futures trading, yet it is frequently misunderstood. In commodity futures, margin is not a down payment or a loan instalment - it is a performance bond deposited with the clearing corporation to ensure that both buyers and sellers honour their obligations as prices fluctuate.

There are several types of margin that apply to commodity futures positions in India.

Initial margin (also called SPAN margin) is the amount you must deposit when you first enter a futures position. It is calculated using the Standard Portfolio Analysis of Risk (SPAN) methodology, which estimates the worst likely loss the position might suffer over a single trading day under a range of price and volatility scenarios. SPAN margin is computed dynamically - it changes as price volatility changes. For a commodity like crude oil, which can move several percent in a single session, initial margins are relatively high. For relatively stable commodities, margins may be lower. Exchanges typically express initial margins as a percentage of the contract value and publish them on their websites daily.

For illustration: if crude oil is trading at Rs 6,000 per barrel and the lot size is 100 barrels, the contract value is Rs 6,00,000. If the initial margin is 10%, you need Rs 60,000 to trade one lot. With Rs 60,000, you control an exposure of Rs 6,00,000 - a leverage ratio of 10:1. This leverage amplifies both gains and losses.

Exposure margin (also called extreme loss margin) is an additional margin collected over and above the SPAN margin to cover losses that might occur in extreme market conditions beyond the SPAN model's estimates. Exchanges set this as a fixed percentage of the contract value or notional value.

Additional margins may be levied during periods of unusual volatility or when open interest in a contract builds up close to the delivery period. These are sometimes called special margins or delivery-related margins. As a futures contract approaches its expiry, exchanges typically increase margin requirements substantially - sometimes to 25–50% or even the full contract value - to discourage pure speculators from holding positions into the delivery period. This mechanism helps ensure that only participants with genuine delivery intent remain in the market near expiry.

Mark-to-market (MTM) margin is different from the above. It represents daily gains and losses that are credited to or debited from your account every evening. If your position has moved against you, the MTM loss is debited immediately, and you must replenish your account to maintain the required margin. If the position has moved in your favour, the MTM gain is credited and becomes available for withdrawal or for funding other trades.

Variation margin is the term sometimes used interchangeably with MTM margin calls. When your account balance falls below the maintenance margin level (a threshold set by the broker, typically lower than the initial margin), the broker issues a margin call requiring you to top up immediately.

It is crucial to understand that in commodity futures, margin calls can come quickly and require same-day or next-morning response. Failure to meet a margin call gives the broker the right to square off your position without further notice, potentially crystallising a large loss. This is why position sizing and keeping adequate buffer in your trading account are essential risk management practices.

Mark-to-Market Settlement: How Daily Gains and Losses Are Calculated

One of the defining features of exchange-traded futures - distinguishing them from over-the-counter forward contracts - is daily mark-to-market (MTM) settlement. This mechanism was designed to prevent losses from accumulating over the life of a contract, reducing the risk of a participant defaulting on a large accumulated obligation at expiry.

Here is how MTM settlement works in the Indian commodity derivatives market:

At the end of each trading day, the clearing corporation computes a daily settlement price (DSP) for each contract. For most commodity contracts, the DSP is typically the volume-weighted average price of trades executed during the last 30 minutes of trading. If trading in the last 30 minutes is thin, alternative methods such as a theoretical price model may be used.

The clearing corporation then compares the DSP of the current day with the previous day's DSP (or with the trade price, for positions entered on the current day). The difference, multiplied by the lot size and the number of lots held, is the MTM gain or loss.

Example of MTM in action: You buy 2 lots of gold futures (each lot = 1 kg) at Rs 58,000 per 10 grams. The DSP at the end of the day is Rs 57,800 per 10 grams. Your MTM loss = (58,000 - 57,800) × 100 grams per 10-gram unit × 2 lots... Actually let us express it simply: the price fell by Rs 200 per 10 grams, and 1 kg = 100 units of 10 grams, so loss per lot = Rs 200 × 100 = Rs 20,000. For 2 lots, total MTM loss = Rs 40,000, which is debited from your account that same evening.

Conversely, if the price had risen by Rs 200 per 10 grams, Rs 40,000 would be credited to your account.

This daily settlement process means that by the time a contract reaches its final settlement date, most of the price movement has already been settled through MTM. The final settlement amount is typically small relative to the total price movement over the contract's life.

For the broader financial system, daily MTM settlement is enormously important. It prevents the build-up of large unrealised losses that could destabilise individual participants or, in extreme cases, the clearing corporation itself. It is one reason why futures markets continued to function even during periods of high volatility, such as the dramatic crude oil price swings seen in 2020.

For you as a trader, the practical implication is straightforward: you must have sufficient funds in your trading account not just to cover the initial margin, but also to absorb potential MTM debits on bad days. Experienced commodity traders typically keep a buffer of at least 1.5 to 2 times the initial margin in their accounts at all times.

Settlement Methods: Cash Settlement vs Physical Delivery

When a commodity futures contract reaches its expiry, it must be settled. Indian commodity exchanges use two broad methods: cash settlement and physical delivery. The choice of settlement method has profound practical implications and is a key factor in deciding which contracts you should trade, especially as expiry approaches.

Cash settlement is simpler and more common for retail participants. Under cash settlement, no physical commodity changes hands. Instead, the profit or loss is calculated as the difference between the final settlement price and the participant's entry price (after accounting for all daily MTM settlements already made), and the net amount is paid or received in cash. The final settlement price for cash-settled contracts is usually derived from an external benchmark - for example, the final settlement price for crude oil futures on MCX may be linked to the NYMEX WTI crude price converted to Indian rupees at the RBI reference rate, or to a domestic poll-based price.

Cash-settled contracts include natural gas, many base metal contracts, and some agricultural contracts. Retail traders who wish to express views on price direction without worrying about commodity logistics typically prefer these contracts.

Physical delivery means that on expiry, buyers must pay the full contract value and take delivery of the physical commodity, while sellers must deliver the commodity to an approved warehouse or vault. This is where commodity futures genuinely connect the financial market to the physical economy.

For gold futures on MCX, physical delivery involves delivering 995-purity or higher gold bars to an MCX-approved vault. The seller (short position holder opting for delivery) submits a delivery intention notice, and the clearing corporation matches buyers and sellers. The buyer pays the contract value (not just the margin), takes ownership of the gold, and can later withdraw it from the vault by paying applicable charges.

For agricultural commodities on NCDEX, delivery involves depositing produce that meets exchange-specified quality standards (grade, moisture content, contamination limits) at approved warehouses. The warehouse issues electronic negotiable warehouse receipts (eNWRs), which serve as title documents.

The delivery process has several steps and timelines: 1. Delivery intention period: typically 2–4 days before expiry, participants who wish to give or take delivery must notify the exchange. 2. Matching: the clearing corporation matches delivery intentions, pairing buyers and sellers. 3. Delivery and payment: the seller delivers the commodity to the approved warehouse; the buyer makes full payment to the clearing corporation, which releases funds to the seller. 4. Receipt issuance: the buyer receives the warehouse receipt or vault confirmation.

For retail traders who do not want physical delivery, the golden rule is to close your position before the delivery intention period begins. Failing to do so can result in compulsory delivery obligations, which can be operationally and financially burdensome. Brokers typically send alerts and may even square off client positions automatically if they detect delivery-intent positions among retail clients without a demat-linked commodity account set up for delivery.

Delivery margins: As noted earlier, margins increase sharply in the delivery period to ensure that only serious delivery participants remain. Failing to honour a delivery obligation attracts heavy penalties from the clearing corporation, including suspension and blacklisting from the exchange.

Position Limits and Open Interest: Regulatory Safeguards

Position limits are one of the most important yet least-discussed regulatory tools in commodity derivatives markets. They cap the number of contracts any single entity - or all clients of a broker combined - can hold at any time, preventing market cornering, hoarding, and systemic risk.

SEBI prescribes position limits for commodity derivatives at multiple levels: individual client limits, member limits (for brokers), and market-wide open interest limits. The actual numbers vary by commodity and are published by exchanges. Generally, position limits for agri-commodities are stricter than for non-agri commodities, reflecting concerns about food security and price manipulation.

For hedgers, SEBI provides for higher position limits if they can demonstrate genuine underlying physical market exposure. A company that imports large quantities of crude oil, for instance, may apply for an enhanced position limit on crude futures proportional to its actual import volumes. Documentation requirements are detailed and must be submitted to the exchange.

Open interest (OI) is the total number of outstanding futures contracts that have not been settled or closed. Rising open interest alongside rising prices is generally interpreted as new money entering the market in the direction of the trend, suggesting strength. Falling open interest alongside price movement may indicate that the move is driven by position unwinding rather than fresh conviction. Commodity analysts watch OI data closely for clues about market sentiment.

When open interest in a contract reaches the market-wide position limit, the exchange may impose additional curbs - for example, allowing only offsetting (closing) trades, not fresh (opening) trades. This has occurred in various agri-contracts during periods of supply stress and is important for traders to monitor.

SEBI also mandates the reporting of large trader positions above prescribed thresholds. This allows the regulator to monitor concentration risk and take action if a single entity is attempting to manipulate the market.

For retail traders, position limits are rarely a binding constraint unless you are trading extremely large sizes. However, keeping an eye on market-wide OI relative to the position limit can warn you when a contract is approaching a point where liquidity conditions may change abruptly.

Pricing of Commodity Futures: Cost-of-Carry and Basis

Understanding why a futures price differs from the current spot price is essential for any serious commodity market participant. The theoretical relationship between spot and futures prices is explained by the cost-of-carry model.

The cost-of-carry model states that the fair value of a futures contract is:

Futures Price = Spot Price × e^(r+s–c)×T

Or in simpler approximation: Futures Price ≈ Spot Price + (Interest cost + Storage cost – Convenience yield) for the period until expiry.

Interest cost reflects the opportunity cost of funds locked up in the physical commodity. If you buy gold today at Rs 58,000 per 10 grams and hold it for three months, you forgo interest that could have been earned on that capital. This cost is embedded in the futures price.

Storage cost is the cost of physically holding the commodity - warehouse rent, insurance, handling charges. For bulky agricultural commodities, storage costs can be significant and seasonal.

Convenience yield is a somewhat abstract concept representing the benefit of holding the physical commodity rather than the futures contract. When a commodity is in short supply, holders of physical inventory can earn a premium by supplying to the market immediately - this premium is the convenience yield. High convenience yield pulls the futures price below the spot price, creating a condition called backwardation.

When futures price > spot price (the normal situation for storable commodities with carrying costs), the market is said to be in contango. When futures price < spot price, the market is in backwardation. In the crude oil market, for example, contango conditions prevailed for much of 2020 when oversupply caused near-term prices to crash while longer-dated futures remained higher.

Basis is the difference between the local spot price and the futures price: Basis = Spot Price – Futures Price. For a hedger, basis risk - the uncertainty about what the basis will be at the time the hedge is lifted - can mean the hedge is imperfect. In well-developed markets with good delivery infrastructure, basis is relatively stable and predictable.

In India, basis behaviour is also influenced by import duties, local supply-demand factors, currency movements (since many commodities are internationally priced in USD), and seasonal factors for agricultural commodities. Understanding basis dynamics is important for anyone using commodity futures for hedging rather than pure speculation.

As a futures contract approaches expiry, its price converges toward the spot price. This is called convergence, and it is enforced by arbitrage: if the futures price diverges significantly from the deliverable spot price near expiry, arbitrageurs will exploit the difference until it disappears. Convergence is one of the most reliable phenomena in futures markets and is mathematically guaranteed by the delivery mechanism.

Commodity Futures and Taxation in India

Taxation of commodity derivatives income in India has evolved over the years and is governed by the Income Tax Act, with specific rates and provisions that may be updated through each Finance Act. The following is an educational overview; for precise and current rates and treatment, always refer to the latest Finance Act or consult a qualified tax professional.

Commodity derivatives that are traded on a recognised exchange (MCX, NCDEX, etc.) and are electronically settled are treated as non-speculative business income for income tax purposes, subject to Securities Transaction Tax (STT) applicability. The distinction from speculative income matters because non-speculative business losses can be set off against other income heads (with certain restrictions) and carried forward for a longer period.

Note that for many years, commodity futures did not attract STT. Commodity Transaction Tax (CTT) was introduced instead, applicable to non-agricultural commodity derivatives. CTT is levied on the seller of commodity futures contracts. CTT-paid transactions are treated as non-speculative business income, which means losses from such trades can be set off against other business income and carried forward for up to eight assessment years.

Agricultural commodity derivatives traded on recognised exchanges have historically had different CTT treatment - they were exempt from CTT in many periods, which meant their tax character was that of speculative transactions. However, this is an area where rules have changed over time, so referring to the latest Finance Act is essential.

Goods and Services Tax (GST) implications arise when physical delivery actually occurs. The commodity received through delivery is treated as a supply of goods and GST applies at the applicable rate for that commodity. This adds to the effective cost for anyone taking actual delivery and should be factored into the economics of delivery-based trades.

For retail investors, record-keeping is critical. Your broker's transaction statements, contract notes, and annual tax summary will form the basis of your income tax computation. Profit and loss from futures must be reported under the head "Profits and Gains from Business or Profession" (PGBP), which requires filing ITR-3 rather than the simpler ITR-1 or ITR-2. Maintaining a proper books of account (or at least a reconciled profit and loss statement) and getting a tax audit if turnover crosses the prescribed threshold are obligations that commodity traders often overlook.

Turnover for purposes of commodity futures is typically computed as the sum of absolute values of all profits and losses from futures trades (not the gross contract value), but the exact computation method should be confirmed from the latest ICAI guidance and Income Tax provisions each year.

Commodity Futures vs Other Investment Instruments: A Comparative View

Investors sometimes ask whether commodity futures are better or worse than other ways of gaining exposure to commodities, such as commodity ETFs, commodity stocks, or sovereign gold bonds. There is no single correct answer - the right choice depends on your objective, time horizon, and risk tolerance. Here is a brief educational comparison.

Commodity futures offer direct, leveraged exposure to commodity price movements. They are the most efficient instrument for hedging physical commodity risk and for short-term speculation. However, futures have expiry dates requiring active management (rolling over to the next contract), leverage that can result in losses exceeding initial capital, and mark-to-market flows that require cash liquidity. They are generally not suitable as a "buy and hold" investment for retail individuals.

Commodity ETFs (such as Gold ETFs listed on NSE and BSE) offer exposure to commodity prices without leverage, without delivery obligations, and without expiry management. They can be held in a regular demat account, are liquid during market hours, and are taxed as equity or non-equity based on their structure. For retail investors seeking commodity exposure as part of a long-term portfolio, ETFs are simpler and safer than futures.

Sovereign Gold Bonds (SGBs) issued by the Government of India offer gold price exposure plus an annual interest, with tax advantages on redemption at maturity. They are suitable for very long-term gold holders.

Commodity company stocks - shares of oil exploration companies, mining companies, or agri-businesses - offer indirect exposure with additional company-specific risks and benefits (management quality, reserves, operating leverage). They are subject to equity market sentiment as well as commodity price movements.

Commodity options, available on MCX, offer asymmetric risk profiles: the buyer of a call or put option can only lose the premium paid, making the maximum loss known in advance, while futures have theoretically unlimited downside. Options are increasingly popular tools for hedgers and sophisticated speculators. However, options pricing involves volatility and time decay considerations that add complexity.

In practice, large hedgers may combine futures and options in spread strategies to optimise their risk-cost trade-off. Retail investors are generally advised to start with futures before exploring options, as options require an additional layer of understanding.

The key point is that each instrument has its niche. Commodity futures are most powerful in the hands of participants who understand leverage, have the liquidity to meet margin calls, are focused on shorter-term price moves or need to hedge physical exposure, and have the time to actively monitor positions. They are not suitable as a set-and-forget investment.

Example

Key benefits

How it works

1. 1
   Open a Commodity Trading Account

   Activate commodity derivatives trading through a SEBI-registered broker. You will need a linked bank account and, for physically settled contracts, a demat account configured for commodity delivery.

2. 2
   Select a Contract and Check Specifications

   Choose the commodity (e.g., gold, crude oil, copper), the expiry month, and the contract variant (standard, mini, or micro) from the exchange's published contract specifications on MCX or NCDEX.

3. 3
   Deposit the Required Margin

   Transfer funds to your trading account equivalent to at least the SPAN margin plus exposure margin for your intended position, plus a buffer to absorb MTM fluctuations.

4. 4
   Place Your Buy or Sell Order

   Enter the lot quantity, price type (limit or market), and order validity through your broker's trading platform. Once matched, you hold an open futures position.

5. 5
   Monitor MTM Settlement Daily

   Each evening, the clearing corporation computes gains or losses against the daily settlement price. Gains are credited; losses are debited from your account. Ensure your balance stays above the maintenance margin level.

6. 6
   Manage or Roll the Position

   Before the delivery intention period, either square off the position by placing an opposite trade, or roll it to the next month's contract if you want to maintain the exposure beyond the current expiry.

7. 7
   Final Settlement

   If you hold the position to expiry, it is settled either in cash (at the final settlement price) or through physical delivery, depending on the contract type and whether you have submitted a delivery intention notice.

Formula

Futures Fair Value ≈ Spot Price + (Spot Price × Risk-Free Rate × T/365) + Storage Costs – Convenience Yield
MTM Gain/Loss = (Current DSP – Previous DSP) × Lot Size × Number of Lots

Key takeaways

Frequently asked questions

Related terms