Market regulator SEBI cleared the deck for commodity options in June by issuing trading and settlement guidelines. Options are derivative contracts that give the buyer the right to buy or sell a specific asset a commodity here at a specified price in future. There are two parties to an option contract — a buyer and a seller also called the writer and there are two types of options: The buyer of an option is the one who by paying the premium buys the right to exercise his option on the seller.
The seller is the one who receives the premium and is obliged to buy in a put option or sell in a call option if the buyer exercises his right. So, for a seller in an option contract, the profit is limited to the premium amount but loss can be unlimited.
This tool is primarily designed with hedgers in mind, be it farmers or commodity traders, who would find buying options useful. Commodity market participants have been lobbying for options for a long time. It is seen as a tool that will deepen the market by bringing in more investors. Currently, many of these participants hedge in markets outside the country. If institutions including banks and mutual funds are given a green flag to step into the commodities derivatives market, volumes can improve materially, and reduce impact cost for hedgers and traders.
Recently, SEBI allowed some institutional investors to take positions in commodity derivatives. This should improve volumes and enable better price discovery. Options are better hedging-and-trading tools than futures. Losses are limited for the buyer and costs are lower. In a futures contract, a trader will be required to pay an initial margin and also mark-to-market margin based on volatility in market price.
In options, the outgo is limited to the premium the trader pays on the contract. So, if you want to lock-in to the price of a commodity you have or want to bet on, options offer a cheaper and safer choice. You can hedge your price risk effectively with options.
Hedgers would do well to square off resultant futures positions as this could subject them to new price risk. Editorial Columns Letters Books Blogs. Get more of your favourite news delivered to your inbox. Please Wait while comments are loading This article is closed for comments. Please Email the Editor. Ashima Goyal Chitra Narayanan C.
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