What are the premium and discount in futures trading?
If a particular future price is greater than its spot price is called the premium and if the future price is less than its spot price which is called as discount. If a future is trading on a higher premium or highest discount then it will be suitable for hedging.
Why high premium and high discount in MCX and NCDEX futures?
Commonly a future means it will trade in premium and discount. The future will trade mostly in premium. This applies to both commodity and stock. In commodity the difference between the premium and discount will be high. This is because the commodity market will be more volatile. I.e. gold, silver, crude oil and agro product’s price will change rapidly. If the future’s is trading at a higher premium and discount the trader will get affected. Sometimes it may book profit, but most of the times there is a chance of loss. To make a good use of this the trader should be able to calculate the spot price correctly.
We are repeating to every investor that future and option is not trading for the traders to earn in the market. The future and option are trading only for hedging purposes and not for investors to earn.
Who benefit from High premium and high discount futures?
Future and option trading is a trading contract used for hedging. A trader having a particular asset will hedge with the future based on the price difference that is trading in the market. I.e. without selling the asset (spot) will hedge in the future. Commonly hedging will be used in the stock market, commodities and currencies. A trader who has more assets will hedge in the market. If the future is trading with high premiums and discount then surely it will benefit the traders who are hedging.
How to hedging in commodity products?
We are providing an example for hedging and in the same way all the commodity products will be hedged. For example, consider the turmeric, which is trading in NCDEX. Before five years the lifetime high of spot turmeric has reached 17000 then again when spot turmeric is trading at 12,000 the turmeric’s next 3 contract future has traded around 6500 to 7300. Nearly around 5000 rupees the turmeric future has traded at discount. This is the highest discount price of turmeric till now. That time the lot size of turmeric future is 100. In this case if a trader has 100 kilograms of turmeric they can sell that on the spot market and if they buy in the future they will gain a huge profit. During expiry the turmeric future and spot price will be same. So the trader will earn around 5, 00,000 rupees.(lot size 100* 5000). 5000 is the gap price between the spot and future. If the future is trading at a higher premium and discount then by hedging the trader will be earning more profit. If the future is trading in premium, then buying a spot and going short in the future at that time and when the future is trading in at discount selling the spot and buying in the future is the hedging. For the security of the asset and to make profit without any risk the hedging is done by the trader. Not only in commodity but in all forms of trading hedging is used.