Commodity exchange MCX offering option trading in gold earlier this week is a welcome addition to the hedging tools available for local businessmen/traders in the country.
Commodity exchange MCX offering option trading in gold earlier this week is a welcome addition to the hedging tools available for local businessmen/traders in the country. Even today, firms with large exposures to commodities like aluminium or steel actively hedge their positions on global platforms like the London Metal Exchange (LME), but RBI rules only allow this for companies that have foreign exchange earnings. So, while a jeweller supplying to the local market is also exposed to fluctuations in the price of gold globally, under RBI rules, it cannot hedge on platforms like the LME. The advantage of being able to do so now on local exchanges is that, since the trade is in rupees, there is no exchange risk that has to be dealt with as well while trading on global platforms. Over time, as more commodities are added to the list where options are allowed, Indian businessmen will be relatively insulated from sharp fluctuations in prices. While futures are allowed in many commodities even today, they allow users to protect the downside but not benefit from the upside in the manner that options do.
While industry will undoubtedly benefit, farmers will also benefit once this is extended to various farm commodities. Of course, since options can be expensive, they are likely to take off only if the government defrays most of the costs for farmers/associations as it does today in the case of crop insurance.
Options trading in various farm products will then allow farmers to gain from upside movements as well. While it is true that only sophisticated farmers will be able to take advantage of such trading options initially, that is a good enough start. Indeed, if small farmers are organised, as they are in the milk trade under bodies like AMUL, this ensures even they can benefit from the opportunities this throws up.
Once it stabilises, this will also allow the government to do away with many price support measures for various commodities—indeed, the Shanta Kumar committee had recommended this and said that, once there was a robust options trade, FCI could operate with significantly lower buffer stocks. How fast more commodities will be included, of course, will depend upon a lot of things including the ability of the exchanges to generate enough liquidity in the market. If the market for aluminium futures, for instance, is not deep, it is unlikely a Hindalco will participate in it since its entry will destabilise the market.