Fillip to farm sector: Government green-lights options trading on spot commodity prices

Suresh P Iyengar Mumbai | Updated on October 21, 2019

In a move that would make it easy for the farmers to hedge, commodity options can now be settled directly based on spot prices instead of the current practice of options devolving into futures first. The government has issued a notification to this effect which will pave way for online commodity derivatives exchanges to launch options trading based on spot prices.

Currently, for launching options trading, a particular agriculture commodity should have registered a minimum average daily volume of over ₹200 crore on the futures market. For a non-agricultural commodity, it is over ₹1,000 crore. In addition, the options contract, on expiry, devolves into that particular commodity's futures contract. Following this, a trader has to start paying margins, which are not applicable on an options contract.

An options contract allows an options buyer the right, without the obligation, to buy or sell an underlying asset in the form of a commodity at a particular price until a designated date.

Through a notification on September 27, 2016, the government allowed derivatives trading in 91 commodities, including many sensitive commodities such as onion, potato and eggs in the farm sector, and petrol, diesel and methanol in the non-farm segment.

Sanjit Prasad, Managing Director & CEO, Indian Commodity Exchange, said at present, options are allowed based on the liquidity of the futures contract. Now, options will be allowed without a futures contract, provided the physical market is liquid.

“This notification paves the way for options on goods rather than options on futures. We will witness robust growth in the commodity options market, with hedgers using options effectively,” he said.

Narinder Wadhwa, National President, Commodity Participants Association of India, said the decision will pave the way for the integration of the spot market with the derivatives market and will enable the rollout of farmer-friendly new options by commodities exchanges.

It will also provide an opportunity for exchanges to launch options on benchmark spot prices in the farm and non-farm markets, which is not possible in the current framework, wherein norms such as a minimum daily turnover of ₹200 crore in futures contract for trailing one year are a major criteria, he added.

A farmer who is selling his agricultural goods can now buy a ‘put’ or ‘call’ option to hedge his risk depending on how he sees the market for his goods in the near future.

“For the farmers, options in basic form can be like crop insurance. But a major fallout of this could be that it may make them ‘punters’ like the futures and and options in equity market has made out of a large number of small investors,” a commodity market expert says. Farmers can be safe only if they buy or sell futures or options against their own estimated crop yield,” the expert said.

Published on October 21, 2019

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