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Options based on spot commodities to make a debut on exchanges soon

Currently, commodity options have futures contracts as their underliers.

, ET Bureau|
Updated: Oct 21, 2019, 09.26 AM IST
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Commodity Outlook Shutter
Mumbai: In a major move that could meaningfully deepen the 16-year old commodity derivatives segment, the finance ministry has facilitated the launch of options contracts that can be based on an underlying commodity instead of having a futures contract as its underlier at present. Market regulator Sebi will have to issue detailed norms based on the gazette issued by the finance ministry notifying the new rule.

Most exchange officials believe that they would have a choice to continue with the present practice or be able to launch options on commodities on which futures contracts haven’t been launched.

Currently, commodity options have futures contracts as their underliers and by rule get converted, or devolve, into futures contracts prior to expiry. This acts as a disincentive to participants when the options devolve into futures as a margin to trade futures is significantly higher than premiums charged to buy an option.

Now, the hurdle to participants has been removed with the government through a gazette notification on October 18 paving the way for options to be launched directly on 91 commodities, including gold, crude oil, guar seed and edible oil seeds, that are permitted for trading on the commodity derivatives segment.

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The advantage is that all exchanges which offer commodity derivatives segments (CDS), like metals and energy bourse MCX, Agri bourse NCDEX and rivals with significantly smaller CDS’ like NSE, BSE and ICEX, can launch options on commodities in which futures are not available or where futures are relatively illiquid.

The move will put commodity segments offered by the likes of MCX on a par with the practice on equity segments of NSE and BSE which offer index and stock options based on cash market underliers rather than on futures. The potential interest in options based on cash market commodities can be gauged by their stock exchange counterparts, which are based on cash market stocks or indices rather than on futures. NSE data show that traded volume of index futures was Rs 48.1lakh crore in FY 18 against which notional trading volume of call options alone was way higher atRs 710.3 lakh crore while that of index puts was Rs 638.9 lakh crore.

“The MOF notification removes the legal hurdle in launching options on the underlying goods. Otherwise, the regulator was constrained to allow options of futures. Removal of this anomaly will lead to greater participation of hedgers in commodity options market. Earlier, advantages of hedging through options used to get defeated since options used to devolve on the futures before expiry and the hedgers were exposed to the risk of futures market. This was apparent in case of option buyers particularly,” said Sanjit Prasad, MD, ICEX which offers diamond and jute futures.

MCX is the market leader in the CDS, accounting for 91.8 per cent share in FY19, according to Sebi.

The second biggest exchange in CDS was NCDEX with market share of 7.2 per cent, followed by ICEX (0.3 per cent), NMCE, which has since been merged with ICEX (0.2 per cent), BSE (0.4 per cent) and NSE (0.05 per cent).

An MCX spokesperson said that policy enablement “provides for reducing complexities in commodity option products, which currently are ‘options on futures’ that devolves into underlying futures on exercise. We will closely work with stakeholders and SEBI to bring newer option products for benefit of participants.”

NCDEX’s MD Vijay Kumar said his exchange would maintain status quo for the “simple reason” that futures continue to be more liquid than options and that a devolvement facilitated a participant to take or give delivery via options or to exit before being marked for delivery .
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