Spread trading to gain popularity as FMC incentivises trading

Allows exchanges to increase margin benefits to 75% from 50% earlier

The commodity markets regulator has incentivised spread betting on exchanges, for raising the liquidity in far-month contracts across commodities.

The Forward Markets Commission last week issued circulars allowing exchanges to increase margin benefits from 50 per cent to 75 per cent in spread trading in two different contracts of the same commodity. It also gave omnibus permission to facilitate such trades.

Earlier, commodity and contract-specific permissions were granted. April onwards, commodity exchanges will be able to offer incentivised spread trading with higher margin benefits.

Spread trading is an instrument specific to commodity exchanges and is not available on stock exchanges.

In spread trading, also known as spread betting, market participants can trade in the spread or difference in price quoted in the current month contract and the far-month contract. The benefit is sometimes due to seasonal factors or short-term factors, widening or shrinking spreads in two different contracts.

So far, traders were using spread trades for carry-forward positions in two different contracts and feed lower spreads to cut carry-forward costs in exchanges. Some take positions in both contracts when they see the spread will shrink or widen in the future.

“FMC’s move is positive, as this facility will help hedgers and other market participants, and increase liquidity in commodity futures trade beside bringing capital efficiency,” said Raj Benahalkar, chief risk officer, National Commodities and Derivatives Exchange. For example in February and April gold contracts, traders were short in April because the market had expected import duty cut in the Budget. Hence, the price in April was cheaper than in February.

Now, it is understood that exchanges will be able to launch a contract where spreads will be quoted and buying and selling these will automatically result in two trades.

Globally, spread contracts are used widely by market participants for the ease of rolling over positions as well as creating trading strategies based on the price differential between calendar months of the same commodities or even between two different sets of commodities.

In India, FMC has allowed spread trading only where the underlying commodity is the same and contract calendar is different or contract variants are different.

Viral shah, Head - Institutional Business, Geofin Comtrade said, “Recent guidelines issued by FMC to promote spread contracts is a step in the right direction. In volatile commodities like gold and silver, it is very difficult for market participants to roll over positions from the current month to the next month without taking a price risk on the execution side. The circular issued by the FMC finally addresses the missing link of the futures market.” 

He said benefits to market participants are many fold like rolling over of positions without price distortion, ability to create spreads between any two months. Participants can also place limit orders on the spreads and thus reduce impact costs. While some exchanges do have spread windows, the circular on higher margins upto 75% will further incentivise trading, he said. 

In agri-commodities, two different contracts have volatile spreads especially when market arrivals of crop are faster or delayed and monsoon forecasts change. 

Earlier MCX had launched spread contracts in crude oil and gold, where only spread was shown on the screen. Now, such contracts can see a comeback.