The Securities and Exchange Board of India (Sebi) has allowed commodity exchanges to introduce trading in options. The regulator on Wednesday said in a circular sent to exchanges that would require its approval, which will be subject to guidelines that would be announced later. Sebi has refrained from introducing index-based futures as of now. Leading commodity exchanges have theirindices, but Sebi wants to finalise a standard methodology. “Traders need to hedge against price change in a particular commodity and not the overall market and, hence, index futures are not given a priority,” explained a person connected with the development.Samir Shah, managing director and chief executive officer, National Commodity and Derivatives Exchange said, “For farmers, it will be a game changer. It would help them sell their produce in the derivatives market and, thereby, get the benefit of price protection in case price falls below their cost of production and also derive benefit of any rise. Options are also a much better hedging instrument compared to futures."
The exchange is prepared for the launch of options and has also invested in next generation trading technology, gearing towards providing unrivaled levels of performance, he added. He said the exchange was awaiting detailed guidelines from Sebi.
Currently, Sebi has not clarified how many commodities will be permitted and whether both agricultural and non-agri commodities options will be allowed. There is also no clarity on the types of options that will be preferred.
Mrugank Paranjape, MD & CEO, Multi Commodity Exchange of India, said, “Introduction of options would complement existing futures contracts and make Indian commodity derivatives more vibrant and efficient. It will encourage cost-effective hedging for participants like farmers and small and medium enterprises. As the leading commodities exchange, we will work with Sebi to offer this instrument, which will greatly enhance liquidity and hedging efficiency. We are prepared in terms of technology, operations and risk management and await Sebi guidelines to finalise our product offering in the first phase.”
Sebi’s announcement comes on the eve of the first anniversary of its becoming the commodity derivatives market regulator. Recently NITI Ayog member for agriculture and Sebi's commodity derivatives advisory committee Chairman Ramesh Chand had made a presentation to the Union Cabinet on permitting options in commodities. Experts say that the the flexibility of settling contracts either by cash or by delivery in futures is likely to be extended in commodity options too, which will be clarified in Sebi's detailed guidelines.
Vijay Sardana, a commodity expert and member of Sebi’s advisory committee said, “[The] decision is a welcome step and will help farmers, users, importers to manage their commodity risk in an efficient manner.”
Exchanges have to make amendments to the relevant by-laws, rules and regulations to implement options trading. Meanwhile, the central government has notified 91 commodities for derivatives trading under the Securities Contracts (Regulation) Act. Earlier, they were under the Forward Contract Act, which was repealed a year ago.
Sebi also added six new products to the list of commodities on which derivative contracts can be launched and traded. The new items – diamond, tea, eggs, cocoa, pig iron and brass – have taken the number of permitted commodities on the notified list to 91.
WHAT IS AN OPTION?
An option is an instrument that gives buyer the right to buy or sell a security at a pre-determined price after paying a premium to the seller
TYPES OF OPTIONS AND THEIR RELEVANCE
1. European options
These mature at the end of the contract period, and are good risk management tools. European options are allowed on the equity derivatives market
2. American options
Option holders can exercise American options any time during the contract period, which makes it difficult to manage risk
3. Bermudan options
These are mid-way solution between American and European options and can be exercised on pre-determined dates during the contract
COMMODITIES SUITABLE FOR OPTIONS
Sebi has not spelt out which commodities or how many commodities would be allowed for options trading. However, a working group is understood to have recommended to Sebi that there should be a pilot-like launch of options permitting one or two each in agri and non-agri segment. Market experts have proposed options in mustard seed, soya bean, soya oil and guar. In the non-agri segment, gold and crude oil could be considered
Experts say that for agri commodities, farmers should have the choice of delivery-based settlement along with cash-settled options