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Future Contracts are the Underliers of Commodity Options

 28 Oct 2019

In one of the crucial moves that have the potential to intensify the commodity derivative sector, the Indian finance ministry has organized the introduction of options contract that relies on the underlying commodity rather than a futures contract. In order to implement this new regulation by the finance Minster, SEBI (Indian market regulator) will need to release the norm according to the recent gazette. This detailed norm is mainly issued to inform the investors and market participants about the current rule launched by the Indian finance ministry department.

Future Contracts are the Underliers of Commodity Options, Discouraging the Market Participants

If the exchange officials and expert suggestions are considered, people are expected to get an opportunity to keep doing the current practice. Furthermore, professionals believe that they would be allowed to launch certain options on commodities (for which, future contracts are not implemented).

According to the current sources, future contracts are supposed to act as the underliers for the recent commodity options. These commodity options are transformed into future contracts before their expiry period. However, this entire method seems discouraging to the individuals when their commodity options are converted and transformed into future contracts. The reason why it is a disincentive option for market participants is that future contracts are usually traded with a higher margin as compared to the amount charged for purchasing commodity options.

The Issuance of New Norms by Finance Minister

Fortunately, the finance minister along with the Indian government has taken a special measure according to which this problem will be resolved in the coming days. Through the recent norms issued on October 18, 2019, options are supposed to be introduced straight on 91 commodities including but not limited to crude oil, gold, edible oil seeds, guar seed, and other such commodity options that are allowed to be traded or invested in the commodity market.

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The main benefit the participants get here is that all types of commodity exchanges based on CDS (Commodity Derivative Segments) will now be able to introduce options on exchanges. This is mainly lucrative for commodities in which futures contracts are highly illiquid or where futures are not at all applicable. Now, the possible interest in commodity options will be measured on the basis of their stock exchange counterparts instead of the futures contracts. According to the National Stock Exchange statistics, the total amount of futures contracts that were traded in the financial year 2018 was approximately 48.1 Lakh Crore. The estimated trading amount of Call Commodity Options was 710 Lakh Crore, much more than the traded futures.

The Leaders of Commodity Derivative Segment

The new norm eliminates all the problems in launching options on different commodities, which are not based on future contracts. As soon as this legal hurdle is lifted, more and more people will shift their interest in the commodity options market. Currently, MCX is dominating the Commodity Derivative Segments by having a market share of 91.8 percent in the Financial year 2019. The second rank holder is NCDEX accounting for up to 7.2 percent market share.

Also, Read - Can We Make Money By Doing Trading In Futures & Options?



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