The country’s top two commodity exchanges are set to launch options for the first time in October, heralding a new era in commodity trading after the regulator this year allowed the introduction of the new derivative products, along with the existing futures contracts, to deepen the market. Securities and Exchange Board of India (Sebi) has allowed Multi-Commodity Exchange (MCX) to introduce options in gold and the exchange is planning to launch it before Diwali—most likely between October 5 and 13. On its part, NCDEX has asked for Sebi’s permission to start options trading in one of the two commodities — guar seed and soyabean—, its managing director Samir Shah told Fe. It hopes to get approval soon so that it can plan the launch around Diwali, according to Shah. “Guar seed and soyabean are among our top five products. So, keeping with the Sebi rules, we have applied for permission to start options trading in one of these two items,” Shah said on the sidelines of NCDEX Krishi Pragati Awards 2017 held here.
In April, Sebi announced its plan to permit options trading in commodity derivatives, potentially paving the way for a much wider basket of products and improving farmers’ ability to hedge the risk of price fluctuations in their produce better. Also, as market participants point out, the cost of trading in commodity options (both farm and non-farm items) will likely be only a fraction of that for trading in futures—less than a fourth in certain cases. Options could also lead to an enhancement of liquidity in the market, thus strengthening the price discovery process and reducing the trading costs. Since options carry limited downside risk, it could be a good tool for SMEs and farmers to hedge their commodity price exposures.
Sebi formally notified the guidelines in June, allowing each exchange to start options trading in only one commodity initially. It stipulated that options could be launched on futures contract of only those commodities that are among the top five in terms of the exchange’s turnover value of the previous one year. Also, the average daily turnover of underlying futures contracts of such a commodity in the past one year of the exchange must be at least Rs 200 crore for agricultural and agri-processed commodities, and Rs 1,000 crore for non-farm commodities.
Shah had told Fe that the Sebi move to allow options trading would help farmers sell their produce in the derivatives market and thereby get the benefit of price protection in case the price falls below their cost of production and also derive the benefit of any rise in the price. Options are of two kinds: call and put. A call option gives the holder the right but not the obligation to purchase a futures contract at a specific price on or before a certain date. A put option gives the holder the right but not the obligation to sell the futures contract at a specific price on or before a certain date. While call options are commonly used to safeguard against rising prices, put options are usually exercised for protection in case of falling prices.
For instance, a farmer who is growing maize can buy a put option to sell 10 tonne of the commodity at, say, Rs 1,500 per quintal five months from now. If the maize price goes down to Rs 1,300 per quintal, he can exercise his option, making a profit of Rs 200 per quintal. This will offset the notional loss he would incur if he sells the product in the physical market. And if the price of maize goes up to Rs 1,600, he may choose not to exercise his option.
Options give the holder the right to buy or sell the underlying asset at expiration while a futures contract holder is obligated to buy or sell the underlying asset on a future date. The buyer of a commodity option pays a premium to the seller of the option for the right. Presenting the Budget for 2016-17, finance minister Arun Jaitley had announced allowing new products in the commodity derivatives market, including options.