Are these ‘Options’ for us?

Gurumurthy K | Updated on January 12, 2018 Published on May 21, 2017

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Market participants generally welcome ‘options’ trading on commodity derivatives but want to know the nitty-gritty

The Securities and Exchange Board of India (SEBI), at its board meeting last month, approved the proposal to introduce ‘Options’ on commodity derivative exchanges.

The move was a long-awaited development in India’s commodity market. As the news made headlines, we reached out to commodity market participants, both in agri and non-agri segments, to gauge their feelings about this development and what they expect from this product.

To our surprise, barring a few, many commodity market players are still not aware that options are going to be introduced.

Anil Agarwal, who currently uses the futures contract for hedging in oilseeds, says, “No, I am not aware of such a product being launched in the market,” when asked about the news.

The first and foremost challenge for the regulators, exchanges and the brokers could be to spread awareness about the product once it is introduced.

Industry experts feel that a series of product awareness programmes and road-shows must be conducted to make more participants use the new product. A few brokers are already reaching out to their customers about the introduction of options.

Even for others who are aware of and waiting for the launch of options in commodities, there are many questions in their minds seeking clarification.

Since the actual operational framework is yet to be released by SEBI, we sounded out experts and other sources for a broadview on how this product could possibly work.

Why options?

Sonia Singh, who trades in the Silver futures contract actively, is open to trying her hand at options as well, once it is introduced, although she does not know much about how the product works.

“I am open to trade in both futures and options. But before I get a feel of options, I would like to know how options trading scores over trading in futures contract,” states Sonia.

There are two major advantages to choosing options compared to the futures contact. First is cost saving, the second is good risk-reward ratio.

In a futures contract, you will pay a margin amount whereas when you buy an option you pay only the premium, which would be much less and saves your cost of trading. In options, the risk or the loss is restricted to the premium you pay and the profit is unlimited.

Also, different strategies are available which can be used simultaneously when you actively trade in options.

How is it settled?

According to SEBI’s consultation paper, the futures contract will be used as an underlying for the options that are going to be introduced. This has increased the confusion in the market as to how this product will operate and how the settlement will take place.

The regulators have also hinted that cash settlement will not be permitted in commodity options unlike in the case of equities.

So, for genuine hedgers like Baburaj, who uses the exchange to hedge his positions in cotton, how the settlement will take place remains a question.

“Introducing options in commodities is a very good move for hedgers like me. But I would like more clarity on how the settlement will happen before I start using options as my hedging tool,” says Baburaj.

Sources from a leading exchange in the country elaborate the possible way in which this could work. First, for settlement, the options will be converted into futures positions. This could happen a few days, say, three to five days before the futures contract expires. Upon conversion, the futures contract can be settled at the time of expiry for delivery. So, those who intend to take delivery can hold the position in options until expiry which will then be converted into a futures contract and then be processed for delivery as per the guidelines provided for futures contract settlement.

More clarity regarding the settlement will be available only when SEBI releases the actual operational framework. So, one should wait until then.

Then there are those who say the concept of delivery is not reality even now and so the confusion on the settlement front in the options contract does not matter.

Mahendra Agarwal, an active hedger of cotton, says, “It is a misconception that delivery is taken through exchanges. No actual delivery takes place in the exchange.”

Clarity on CTT

The re-introduction of the Commodity Transaction Tax (CTT) for the non-agri segment in Budget 2013-14 saw the exchange volumes spiralling lower. For bullion traders like Piyush and for active participants in base metals like Harsha, whether CTT will be applicable on options remains a concern.

“CTT is one of the major costs that I incur while trading in gold. If the same is applicable to options, then it will make options costlier,” says Piyush. True, CTT will be a worry if applicable, as that would increase the cost of options. Commodity participants will be closely watching the final guidelines from SEBI for this.

There are two possibilities. Either the CTT can be imposed if you square-off your position before expiry.

Or upon expiry, when your options contract gets converted into futures contract, the CTT, which is already one of the cost components of the futures, might kick in at this time.

Such a tax could make options unviable for institutions as it would increase the cost, say sources from exchanges.

Operational challenges

Summing up, implementing options trading, while sounding good on paper, comes with its own operational challenges.

As pointed out by market participants we chatted with, creating awareness about the product is vital.

The exchanges and brokers should work together to educate market players.

According to market sources, in the initial months, only a couple of commodities will be introduced in the options segment and later, based on the market’s reaction and acceptability, the segment will be widened to include more commodities.

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Published on May 21, 2017
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