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Published on Friday, August 24, 2018 by Chittorgarh.com Team | Modified on Thursday, February 29, 2024
Commodity options are derivative contracts. However, unlike stock options, which are derived from stocks, commodity options are derived from commodity futures. Similar to stock options, the contract consists of buying the underlying asset at a certain time and a certain price.
Commodity options are derived from commodity futures. Similar to regular options, the buyer of a commodities option has the right, but not the obligation, to fulfil the contract. If he believes that the contract is profitable, he can either exercise it or let it expire. A commodity option contract is purchased by buyers in exchange for a premium.
Commodity options trading has a long history in India. SEBI introduced options trading in commodities in 2017. Before that, only commodity futures trading was allowed. The introduction of commodity options is a great tool for investors to diversify and make profits. Here's everything you need to know about commodity options trading.
There are buyers are sellers in commodity options. The buyer of the option has the right, but not the obligation, to honor the contract. If he sees the deal is profitable then he can exercise the contract or else choose to let it expire. The buyers pay a premium to buy a commodity options contract. The seller has to honor the contract when the buyer chooses to exercise it. The seller receives the premium when entering a contract.
There are two primary commodity options: Call Options and Put Options.
Call option: This gives the investor the right to buy the primary commodity at a predetermined price or strike price on the expiration date of the contract. If the investor decides to exercise his right to buy, the contract is automatically converted into a futures contract.
Put option: his option gives the investor the right to sell the primary commodity at a predetermined price when the contract expires.
The expiry date is always the last Thursday of the month.
The expiry of options contracts is different for all commodities and depends on the commodity class.
If the expiry date falls on a public holiday, the expiry date for all contracts is brought forward to the previous business day.
The types of commodities for options trading can be divided into three broad categories
The trading hours for commodities in India are from Monday to Friday. It takes place from 9 am to 11:30/11:55 pm. There is no trading on Saturdays and Sundays and on certain public holidays.
Investors can trade commodity contracts on the MCX and NCDEX exchanges. Various full-service commodity brokers in India offer commodity trading services. Unlike a discount broker, a full-service broker offers both online and offline trading through a network of branches and franchise offices. Here is a list of MCX commodity brokers in India.
Traders can use any strategy for commodity options trading that they can use for stock or index options. Some of them are:
Commodity options are similar to stock or equity options. However, there are some important differences between the two that investors should be aware of, such as
Characteristics |
Equity Options |
Commodity Options |
---|---|---|
Underlying |
Equity, Nifty, Bank Nifty |
Commodity Futures |
Lot size |
As decided by the exchange |
Lot size of Future contracts |
Exercise Style |
Stock Options- American Index Options- European |
European |
Premium Pricing Model |
Black & Scholes |
Black 76 |
Devolvement |
Expires worthless if not exercised |
Converted into Futures contract if not squared off |
Moneyness |
ITM, OTM and ATM |
ITM, OTM, CTM and ATM |
Expiry Date |
Last Thursday of month |
3 days ahead of the expiry of the Futures contract |
So there are many similarities between equity and commodity options, but also some differences, as the table above shows. Let's understand two main differences between equity and commodity options: Devolvement and Moneyness.
Option Position |
Devolvement |
---|---|
Long Call |
Long Futures |
Short Call |
Short Futures |
Long Put |
Short Futures |
Short Put |
Long Futures. |
On expiry day, here's how the devolvement of the options contracts takes place: -
The Daily Settlement Price (DSP) of the Futures is taken as reference for Commodity options.
Say the DSP of a commodity option on the expiry date is 90. Now, assuming the strike interval of this commodity to 10 points, its moneyness will be-
ATM- 90
CTM- 70,80,90,100 and 110.
OTM- All strikes above 90 including 100 and 110.
ITM = All strikes below 90 including 70 and 80
Strike |
Devolvement |
---|---|
ITM |
Automatically devolved unless a 'contrary instruction' is given. |
CTM |
Devolved on 'explicit instruction'. If the 'explicit instruction' is not given then the contract expires worthless. |
OTM |
Expires worthless. |
POSITION |
PROFIT POTENTIAL |
LOSS POTENTIAL |
---|---|---|
When you BUY a CALL option |
Unlimited depends on the extent of price rise above strike price |
Limited to the premium paid |
When you SELL a CALL option |
Limited to the premium received while selling the contract |
Unlimited depends on the extent of price rise above the strike price |
When you BUY a PUT option |
Unlimited depends on the extent of price falling down to zero |
Limited to the premium paid |
When you SELL a PUT option |
Limited to the premium received while selling the contract |
Unlimited depends on the extent of price falling down to zero |
SEBI introduced options trading in commodities in 2017. Before that, only commodity futures trading was allowed. The introduction of commodity options is a great tool for investors to diversify and make profits.
Commodity options are derivative contracts that derive their value from underlying commodity futures contracts. Trading commodity options gives you the right to buy (call option) or sell (put option) the underlying commodity futures contracts at predetermined prices on the expiration date of the contract.
When trading commodity options, you enter into buy/sell positions in commodities option contracts that expire in different months with different strike prices. If the price moves in your favor during the term of the contract, you make a profit. If the price moves unfavorably, you suffer a loss.
Yes, you can buy options on commodities. Commodity options are essentially options on commodity futures, as opposed to equity options, which are options on the spot.
Commodity options expire a few days before the first tender date of the futures contract. This means that there are several days between the expiry date of the futures contract and the options contract.
Investors can trade commodity options on the MCX and NCDEX. MCX stands for Multi Commodity Exchange of India Limited, a commodity exchange based in India, and NCDEX stands for National Commodity and Derivatives Exchange Limited, an Indian online commodity and derivatives exchange based in India.
Yes, commodity options trading is authorized by the market regulators in India. Traders can trade commodity options in the commodity futures market and not in the spot commodity market as the spot commodity market in India is regulated by the state governments while SEBI only regulates the commodity derivatives market.
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