“There are decades where nothing happens, and there are weeks where decades happen” – Vladimir Lenin
In fact, there are days! This precisely implies to the unprecedented meltdown in the WTI crude oil contract listed on NYMEX (New York Mercantile Exchange). Since the MCX (Multi Commodity Exchange) relies on the NYMEX rates for pricing its crude oil contracts and therefore impacted many commodity traders and brokers to its consequential impact on the settlement price. The May futures on the New York exchange had settled at an unprecedented negative rate: Minus $37.63 a barrel. For those who want to get a good understanding of the Crude oil markets to check out the Crude oil Chapter on our School of Stocks.
So what happened exactly?
Crude oil is one of the most actively traded commodities on MCX and It is a cash-settled monthly derivative contract. Crude oil has had a huge amount of volatility in the last few weeks and has continuously breached it’s threshold limits many times followed by cooldown period. On Monday 20th April, MCX Crude oil contract was trading at Rs 965, the market woke up the next day to an overnight crash in crude oil prices at NYMEX, where prices plunged to a negative $37 and the final settlement price decided to -Rs 2880 per barrel.
Until Monday, the margin required to buy one lot of crude oil is approximately Rs. 80,000 and as per the open price i.e 1385, the contract value is 1,38,500 so, the margin required is just at 58% of the contract value. Crude Oil April contract settled at -Rs 2880 which is down by 398% or a loss of Rs. 3.85 lac for a trader who is holding a long position from it’s previous close. Here the loss incurred by the client is over and above the margin money he brought in and the onus is on the brokerage firms to recover the amount from its clients. There were 11100 contracts open at 5 pm on Monday, which means a killion loss of Rs 450 crores for the Commodity brokerages and the exchange went ahead to debit the money from brokers’ accounts to settle the contract. Fortunately, we don’t have any exposure here!
Risk management policies in Commodities contracts
Due to this settlement debacle, affected brokers have filed a petition in the Bombay High Court to determine the fate of this controversy. It is interesting to note that no amount of money/margin collected from the clients can cover such kind of price risk and many big brokerages are staring at clients defaults. Commodity brokers and market veterans feared that the market may see a negative expiry again and hence it’s a need of the hour to take curative measures to safeguard ourselves and facilitate uninterrupted trading in commodities. Therefore, we’re introducing the following risk management policies in physical and cash-settled commodities and will be applicable hereon.
- An additional margin of 300% of the contract value will need to be introduced one day prior to expiry day on all open cash-settled commodity contracts. If you have a position without sufficient margins (including additional margin) to hold a futures/options position before expiry, your position will be squared off by our RMS team anytime during the day. Commodity futures contracts namely – Crude oil, Natural Gas, CPO (Crude Palm Oil) are cash-settled.
- Intraday products (Intraday, CO, BO) will not be allowed during the last two days of expiry for cash-settled commodity contracts.
- MCX commodity contracts that come under compulsory delivery will be closed off before the staggered delivery tender period i.e. 5 days prior to the expiry date to avoid physical delivery. This policy will be applicable to all the commodity contracts which fall under compulsory delivery, namely –
– Agri Contracts – Mentha Oil, Rbdpmolein & Cotton
– Base Metal Contracts – Alumni, Nickel, Copper, Lead mini and Zinc mini
– Gold Contracts – Gold Petal & Gold Guinea
– Precious Metal Contracts – Silver and GoldMFor example refer to this latest post Gold Petal & Gold Guinea Contracts Expiry On 30th April, 2020 – Compulsory Delivery on our Notice Board.
As a brokerage, we have to take the necessary measures to safeguard everyone’s interests and such risk management measures are a result of the ongoing changes in the financial environment. We encourage traders to estimate the risks carefully before entering into trades and rollover near-month positions to the next/far month contracts or close the positions before RMS square-off is triggered as per our policies.
Tejas is the Co-Founder & CEO at FYERS, the youngest team to get NSE’s broker license. He has a specialization in finance and has over 10 years of work experience spanning across proprietary trading, risk management, and broking. Tejas & his team started FYERS, a technology-focused brokerage as a mission to transform the trading/investment landscape in India.