Further, with the expected participation of financial institutions, it will add depth to the market and overall increase the efficiency of the price risk transfer mechanism.
With Securities & Exchange Board of India (Sebi) setting the stage for launch of commodity options, market participants are excited about this new product offering, which has the potential to change the landscape of exchange traded commodity markets. Till date, the only instrument available for commodity price risk management is futures. The combination of futures and options would offer hedging strategies to market participants (hedgers, farmers and investors) to protect themselves from unfavourable price moves and effectively hedge their risk exposure. Further, with the expected participation of financial institutions, it will add depth to the market and overall increase the efficiency of the price risk transfer mechanism.
Benefits to investors, farmers
Since options represent a form of price insurance, there will be no margin calls for options purchasers for either buying a call (which are commonly used to protect against rising prices) or put (which are commonly used to protect against falling prices).
Rather, the option purchaser has to pay a one-time premium upfront to the option seller, helping the purchaser know how much he has to pay upfront and what is the maximum risk. Such benefits are not available in any other tool, and shall help the market participants protect themselves against adverse price moves. Also, the premiums payable are significantly low as compared to margins payable for futures positions.
Commodity options would add to enhanced liquidity in the market, lower impact cost, improve price discovery, lower volatility along with increase market stability, and allow quicker information reflection in prices. It would lead to reduction in ignorance about commodities trading, as farmers, hedgers and investors, will understand its benefits more easily.
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Farmers producing the right quality and quantity as per exchange contract specifications, would be encouraged to directly hedge on the exchanges using options. Farmer cooperatives such as NAFED, could also benefit from the same. What is needed, however, is awareness creation through regular trainings at key agri-hubs about the benefits of options and how it can have a positive impact on their well-being. The government could even look at subsidising a part of the option premium for farmers as done in some countries where such an experiment has been successful. Commodity options are the need of the hour in India, as it will go a long way in helping risk mitigation for various market participants, even banks wherein they will be able to hedge their exposure to farm collateral using options.
Farmer and hedgers stand to gain the most, as volatility is the new norm of the day, and the primary consumers and producers of commodities are more interested in protecting their margins unlike the speculators whose interest lies in price direction and volatility. Options will help markets offer longer-term contracts, adding further depth and liquidity.
The writer is chief business officer, Angel Broking.