we have seen the MCX announcing the launch
of options on copper as well as gold and silver. SEBI had permitted
commodity exchanges to offer options on commodity futures and the first
contracts went live in October 2017. The gold commodity options were
launched on the auspicious day of Dhanteras last year. Here is what you
need to know about commodity options.
Why such a delayed launch of commodity options?
The launch of commodity options was
announced last year; a full 14 years after the first commodity options
were launched. Why was there such a delay in the launch of commodity
options? Firstly, the options cannot be launched on the spot commodities
but only on the commodity futures. In case of equities, trading in
equity and F&O is regulated by SEBI. Hence SEBI could simultaneously
launch Futures and Options on the spot price. However, in case of
commodities, only the futures are regulated by SEBI (formerly by FMC),
while the spot markets are regulated by the respective states. Since
SEBI does not have control over the spot markets, the options are being
launched as an option on the commodity futures. Like in case of any
option, this contract will be a right to buy without an obligation to
buy. The only difference is that the underlying asset for the option
will be the Commodity future and not the commodity in spot.
What advantage do you get from commodity trading?
For investors and traders it offers a
low-cost method the risk of commodity price movements. Futures are
symmetric in the sense that profits and losses can be unlimited.
However, options are asymmetric. For the option buyer the losses are
limited to the premium paid but the profits can be unlimited. Thus for
more conservative players in the commodity markets, options can be a
better choice. A farmer looking to hedge risk in the commodity market
can now use options to hedge with lower downside risk. For commodity
traders, there is an added advantage. They can create specific risk
products like covered calls and protective puts to make the best of
price movements with limited risks. Lastly, for large prop desks,
institutions and even for HNIs; the option writing can become an
additional source of fixed earnings.
Five things you must know about commodity options
- Settlement will be slightly different in case of options. In case of commodity futures when you choose delivery in spot, then it has to be intimated to the exchange well in advance. In case of options, if the options are not closed then they automatically devolve into futures with the strike price as the futures price.
- What effectively happens in this case is that if you are holding on to a long call or a short put position, then it devolves into a long futures position. On the other hand, if you holding a long put or a short call position, then it devolves into a short futures position.
- All commodity options will have to be necessarily European in nature. They can only be exercised on the settlement date. Like in case of equity options, you can square up your positions if liquidity is available. But if it is not squared up then it automatically devolves into equivalent lots of futures.
- There is one more difference between F& O expiry in equities and in commodities. In case of equity markets, the futures and options will all expire on the same day. But, in case of commodities, the options will expire a few days ahead of futures to provide for the devolvement of options into futures.
- There are two very important things to remember here. Once the options devolve into futures then the normal margins that are applicable to the futures position will start to apply. Hence option buyers, who have just paid the option premium till now, will now have to pay up the normally applicable margin on futures. Secondly, the settlement leads to devolvement of long calls and short puts into long futures. This is actually a mismatch because the intent of the buyer of the call and the seller of the put are entirely different.
Commodity markets have seen option volumes
pick up. The real value will be known only when more commodities are
brought under the ambit of commodity options.
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