InvestorQ : How farmers can hedge risk on the futures market?
Suhani Mirza made post

How farmers can hedge risk on the futures market?

vidhya Laxmi answered.
3 years ago

The idea of an Indian farmer trading directly in the futures market in commodities appears to be quite incongruous. But that could be the road in the future. Giving the farmer direct access to futures market gives tremendous control over time and price to the farmer. Of course, some minor irritants will have to be ironed out, but it could be an experiment worth the effort. Here are some of the key points to understand while getting farmers integrated with the commodity futures market in India…

Broadly farmers will have two options for hedging their price and time risk in the futures market. Assume that a castor farmer wants to hedge the risk of price going against him in the futures. He can do one of the two things. Firstly, he can directly sell the produce on the commodity futures exchange. On the date of delivery the farmer can directly give delivery of the produce to the exchange accredited farmhouse and can realize the proceeds directly from the exchange. However, the farmer’s produce will have to meet the standard specifications of the exchange in terms of grade and quality. Secondly, the farmer can hedge his price risk by selling futures on the commodity exchange and squaring it up on the date of delivery. For example, if the selling price of Rs.70/KG is locked in by the farmer and if on the date of selling the produce the price has dropped to Rs.66, the farmer sells his produce at Rs.66 and then covers the short position in the market at a profit of Rs.4. This way he anyways realizes his target price of Rs.70/KG. This is how futures market can help the farmer protect his price risk.

However, the futures market in commodities will have to be tweaked to become really useful to the farmer. Currently, futures and spot are not exactly synced together. In most cases the futures market does not have a spot market in the vicinity. Also there are no harmonized testing and grading standards which prevents the product from getting standardized. Here are a few things that can be done to encourage more farmers to participate in commodity futures market.