The introduction of options in the commodity market, which has been a demand for over 12 years, is significant and could be the precursor to the widening the scope of participants to include institutions like banks and mutual funds.
Simply speaking, an option gives the right but not the obligation to go through with the contract for a premium that is paid. Hence, if spot price is Rs 100 and the contract is sold forward at a price of say. Rs 105, in case on the settlement day the price is Rs 110, then the sale at Rs 105 need not take place.
Prima facie, this resembles the MSP of the government, where the farmer has a choice of selling to the government if the price in the market is lower than the MSP; and hence sounds alluring even if there is a cost involved in the form of a premium. Options would be on the futures contract, which means farmers have to be players in the latter to take this advantage.
There are three issues here. First, farmers need to be made aware of how these contracts work which will mean that they have to understand futures. So far, there has been limited participation from this segment, which means that we cannot expect farmers to trade in options.
It would be an instrument for only non-farming players. Second, for the options market to evolve, we need to have institutions trading in the market in a big way. Presently, participation is from the trading community as others are not permitted. Hence, we need to have banks, mutual funds, FIs as active participants.
Third, how deep will this market be? It is argued that while options trading per se may not be too deep, having them will help in increasing volumes of trade in futures as there will be heightened trading activity. This is interesting and it would need to be seen how the market reacts to options once introduced and it is likely that bullion would be the first segment that will evince interest.
This is important because globally, options trading have not been significant in commodities though it has been high in case of single stocks and indices. The table (left) shows that the ratio of options contracts traded to futures contracts in 2015 for all member exchanges of World Federation of Exchanges.
The picture for commodities is not too exciting. While having options is necessary as part of the bouquet that is offered, we must not expect too much too soon.
Simply speaking, an option gives the right but not the obligation to go through with the contract for a premium that is paid. Hence, if spot price is Rs 100 and the contract is sold forward at a price of say. Rs 105, in case on the settlement day the price is Rs 110, then the sale at Rs 105 need not take place.
Prima facie, this resembles the MSP of the government, where the farmer has a choice of selling to the government if the price in the market is lower than the MSP; and hence sounds alluring even if there is a cost involved in the form of a premium. Options would be on the futures contract, which means farmers have to be players in the latter to take this advantage.
There are three issues here. First, farmers need to be made aware of how these contracts work which will mean that they have to understand futures. So far, there has been limited participation from this segment, which means that we cannot expect farmers to trade in options.
It would be an instrument for only non-farming players. Second, for the options market to evolve, we need to have institutions trading in the market in a big way. Presently, participation is from the trading community as others are not permitted. Hence, we need to have banks, mutual funds, FIs as active participants.
Third, how deep will this market be? It is argued that while options trading per se may not be too deep, having them will help in increasing volumes of trade in futures as there will be heightened trading activity. This is interesting and it would need to be seen how the market reacts to options once introduced and it is likely that bullion would be the first segment that will evince interest.
This is important because globally, options trading have not been significant in commodities though it has been high in case of single stocks and indices. The table (left) shows that the ratio of options contracts traded to futures contracts in 2015 for all member exchanges of World Federation of Exchanges.
The picture for commodities is not too exciting. While having options is necessary as part of the bouquet that is offered, we must not expect too much too soon.
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