Warehousing and Commodity Exchange
In the case of financial derivatives, the settlements are in cash most of the time. Cash settlement involves paying the difference in prices between the time the contract was entered into and the time the contract was closed. For example, if a futures derivatives trader buys a stock on a given day for Rs. 1000 and on the expiration of the contract the price is at Rs. 1500, the trader will receive Rs. 500. Similarly, if the stock fell to Rs. 500 on closing day, the trader would have to pay Rs. 500. This would be a loss to him/her.
In dealing with commodity derivatives, there is the option of physical settlement. That is, if the seller chooses to hand over the commodity instead of the difference in cash, the buyer must take physical delivery of the underlying asset. For this, the exchange has to make arrangements for a warehouse to conduct the settlement.
The warehousing system has the following functions to oblige:
– Assign independent storage areas as pointed out by the Exchange for the commodities
– Ensure appropriate grading of the commodities before storage
– Categorically store commodities according to their grade specifications and validity period
– Ascertain that proper measures are taken to ensure that the quantity and grade of commodity are sustained during the storage period. The receipt received by the warehouse with specifications can also be used as collateral for financing.
