Commodity Query

What are commodity options? How will they help traders? When will crude oil options be introduced in India?

Abhishek Patil

Options are derivative contracts which give the buyer the right to buy (if it is a call option) or sell (put option) a specific asset (a commodity here) at a particular price (called strike price) in future. The consideration for exercising the right, paid upfront by the buyer, is called the ‘premium’. These contracts can be used by farmers, commodity processors and middlemen to hedge the price risk by taking a view on future price.

There are two parties to an option contract — a buyer and a seller (also called the writer). The buyer of an option is the one who, by paying the option premium, buys the right to exercise his option on the seller. The seller of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises his right. So, clearly, the game is risky if you are a seller in an option contract, as your profit is limited to the premium amount but loss unlimited. But for all hedgers — be it the farmers or commodity users and traders who will be buying a put option or a call option the risk is limited to the premium. If prices are not favourable to them, they can allow the contract to expire.

Though both future and option contracts are derivative instruments, in the latter, the risk for the buyer of the contract is limited as discussed above. Also, in options, the costs are relatively lower. In a futures contract, a trader will be required to pay an initial margin and also mark-to-market margin based on volatility in market price. In options, the outgo is limited to the premium the trader pays on the contract initially.

The regulator and the commodity derivative exchanges are still working on the finer details of options contracts. Details of commodities on which options might be introduced are also not available, though the buzz is that commodities of high trading interest, including bullion and crude oil from the non-agri basket and a few from the agri side, may see an option contract being launched.

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