Commodity options are now on a par with equities

The government has brought commodity options trading and settlement on a par with equities, creating new norms for farmers and small and medium enterprises to step up hedging. Commodity options can now be settled directly. The current practice is that options devolve on futures first and then futures are settled. But this was not attracting enough hedging because of the complexities involved.

Now brokers hope that once the Securities and Exchange Board of India (Sebi) implements the new norms, hedging by farmers and small and medium units will increase. Through a gazette notification making changes in the Securities and Contract Regulations Act, the government has declared “a contract for purchase and sale of right to buy and sell or a right to buy and sell in future in notified underlying goods as derivative”.

So far options or purchase and sale of rights were not defined and hence when options were introduced by Sebi in commodities settlement, things were found to be complicated. Now there are options on futures but not on goods. That is why options in commodity derivatives devolve on futures rather than the spot (price) of the underlying. With options on goods, options players can give or take delivery of the underlying without getting into futures contracts at the time of expiry.

Secondly, in the case of cash-settled contracts, options can be settled on the spot of the underlying. Thirdly, according to Sanjit Prasad, managing director and chief executive officer of the ICEX (Indian Commodity Exchange), “today options are based on the liquidity of the futures contract; now they can be allowed without futures contacts if the physical market is liquid. Now we have to wait for Sebi’s circular for implementation. Legally, options on goods have been allowed.”