1. Options trading: Why big reforms in agriculture markets are now possible

Options trading: Why big reforms in agriculture markets are now possible

With Sebi deciding to allow options trading, this can potentially revolutionise several markets across the country.

By: | New Delhi | Published: October 1, 2016 6:21 AM
It is only wheat, rice and sugarcane where there is an assured price set by the government—and even here, the impact is uneven across states. (Reuters) It is only wheat, rice and sugarcane where there is an assured price set by the government—and even here, the impact is uneven across states. (Reuters)

With Sebi deciding to allow options trading, this can potentially revolutionise several markets across the country. The biggest change, when various commodity exchanges get Sebi’s permission to offer options in farm produce, will be in the security farmers will get from a more stable price regime. Right now, it is only wheat, rice and sugarcane where there is an assured price set by the government—and even here, the impact is uneven across states. It is because of this that, in his report to incentivise production of pulses, chief economic advisor Arvind Subramanian asked for a minimum buffer stocking of pulses by government agencies like FCI. For the rest of the farmers, extreme price volatility is the order of the day and that is why not too much diversification has taken place despite the shifts in consumer preference—if the potato crop fails and prices skyrocket, this encourages more sowing but the resultant glut drives down prices again, leaving the farmer a net loser. Options offer the best way out since a farmer can now lock into a price in the future, regardless of whether or not government agencies are procuring that season in his area. Unlike futures where the farmer simply has to deliver, as the name suggests, options give the right to buy/sell but not the obligation.

Of course, options don’t come cheap and the only way to make this work is for the government to defray the bulk of the cost, just as it has done in the case of crop insurance. The reason why this would make economic sense is that, once farmer incomes are more assured due to options, the government can afford to disband a large part of the procurement operations of an FCI—just carrying the extra buffer for rice and wheat adds up to over R7,500 crore every year. But naysayers will argue, farmers don’t have the savvy to participate in options markets and it is only traders and corporates—like say, a seller of flour—which will use these facilities. While that is probably true, it doesn’t really matter since the ability of traders/corporates to lock into stable prices will allow them to pass on this benefit to farmers in turn.

An even bigger change can take place in the gold market which also has big implications for India’s balance of payments and the value of the rupee. While the country has been importing around $35 billion of gold every year—it crossed $55 billion in FY12—a significant portion of this could be removed if investors could buy options which would allow them to lock into the possible appreciation of gold over a period of time. When investors buy options from banks, the banks in turn have to buy options in local/overseas markets to cover the price risk—if the options are being bought overseas, options for currency risk also need to be factored in. Once again, given the savings in forex if options trading rises, the government could think of defraying the options’ cost—if it doesn’t, banks cannot offer this product for free and customers will keep on buying gold. In other words, apart from the likely benefits to the corporate sector in hedging risk, options allow for a smarter form of governance.

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