Commodity Calls

‘Commodity options, a game-changer ’

Rajalakshmi Nirmal | Updated on March 10, 2018 Published on April 30, 2017


Samir (1)

While it protects farmers when prices fall, it helps them benefit when prices rise

SEBI, last week, gave the green signal to options in the commodities market. But since amendment of regulations is required to allow options that have commodity futures as underlying, it will take some more time for the product to be rolled out, say experts.

Samir Shah, CEO of NCDEX, shares his take on the development.

SEBI’s announcement on the launch of options was much awaited. How will it impact the market?

By allowing options, SEBI has sent out a clear signal that it wants to take these markets ahead and make them hedger-friendly.

Options give hedgers a form of insurance determined by the strike price of the option. Since options buyers carry virtually no downside risk other than the one-time premium, such risk management products are much-needed in a diversified emerging economy like India with a preponderance of small stakeholders who are risk-averse and need these products the most.

It is expected that options will boost the overall market participation, especially that of the hedging community. It will also complement the existing futures contracts and make the commodities market more robust and efficient.

Will options bring the much-needed depth to the market?

Introducing options trading in India will incentivise market participants, who have been forced to hedge offshore because of the lack of options trading opportunities in India, to bring their business back to India’s bourses. While the introduction of options can help increase liquidity, market depth will come with increased participation by allowing banks and other mutual funds to participate in the commodities market.

With addition of liquidity through commodity options, various associated benefits such as lowering of impact cost, improved market stability, lowering of volatility, reduction in risk of market cornering, improved price discovery, etc. can be seen.

Options will result in futures contract? How beneficial will they be for farmers?

Options is a far more efficient tool for a farmer compared to a futures contract. The farmer can use it to lock in a minimum price for his produce and in the event of prices going up, he can choose not to exercise the option.

For example, a farmer growing maize can buy a put option to sell 10 MT of maize at ₹1,500 per quintal, five months from now.

Two scenarios can play out for him. If the price of maize goes down to ₹1,300 per quintal, he can exercise his option, making a profit of ₹200 per quintal. This will offset the notional loss he will incur when he sells the product in the physical market.

In the event of the price of maize going up to ₹1,600, he can choose to not exercise his option.

While the options contract resulting in a futures contract is a good beginning, it is important to have one designed specifically for farmers, which will result in delivery of the underlying commodity itself.

It could be a hybrid style option, which can have weekly settlement cycles during harvest season, giving the farmer the choice and flexibility to deliver the underlying commodity and settle the option depending on prevailing spot prices.

These options can be a great complement to the government’s MSP programme, going forward.

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Published on April 30, 2017
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