All you need to know about commodity options on futures contract


The country’s markets regulator Securities and the Exchange Board of India (SEBI), back in the month of June had allowed two commodity exchanges MCX and NCDEX to launch an option on a Nifty futures contract.

To this, the commex MCX had declared that before Diwali, they will bring in the new product. NCDEX also plans to introduce an option contract on a primary agri futures contract by the end of the month of October. Here is an effort to make you understand all about the commodity options on the futures contract.

Options contract

An options contract is a derivatives product just like the futures contract but it is different in a way that in that risk is limited for a buyer but the profit is infinite. For the seller, the return is limited to the premium buyers pay to buy an option that allows them to buy a call option or right to sell a put option as an underlier.

The seller has an infinite risk too. In our country, the options contract has a nature of the European style, which can be exercised only after the expiry of the contract. While an American style of the options contract can be exercised any time over the life of a contract and not necessarily after the maturity of the contract.

Exchanges launching European style options

The exchanges may launch the European style options but the options in the commodity market will be decided at the futures price on the expiry with an option for holders to convert their positions to futures contracts and not like in the equity market where options are decided at the cash market rate of stocks or indices.

In the equity segment, the market regulator regulates the cash market and in agri commodities, the board regulates only futures and not the cash market.

Options to make a difference to the market?

The magnitude of the change may not be high in case the participation is not broad based. Until now, the Securities and the Exchange Board of India and the Reserve Bank of India had not permitted the institutional participation by mutual funds or banks which is now allowed, but a category of hedge funds was allowed to get traded.

Most of the participation come from the retail level traders. But the launch of this will be a good tool for the speculators. The speculators provide depth to the market by taking on the risk that hedgers seek to protect themselves against. This might also simplifytheparticipation of the farmers through aggregation.

How the options function in the commodity futures market?

The options that run out of the money at the maturity will be formed at a loss. The options holders ending in the money may decide to either square off at a profit or to get converted into a futures position. However, most of them will choose to square off and not convert to a futures position, as the latter means a higher margining and risk requirements.

Check out Nifty Option Chain and Share Markets News on BloombergQuint.