The Securities and Exchange Board of India (Sebi) approved trading in commodity options on Tuesday. Actual trading in options, however, will take some time to start as the finance ministry will first have to amend the relevant rules, by issuing a notification. The regulatory board has found a way out by which the proposal will not be required to go to parliament. The existing Securities Contract abd Regulation Act (SCRA) gives Sebi all powers to permit options. However settlement will be much more complex than in the case of equity options because in commodities, options will devolve or expire in futures.
Sebi Chairman Ajay Tyagi stated, "Options will expire in the futures of the same commodity and not in cash settlement, as in the case of equities." While he said the details for this are being worked out, sources say once an option expires in futures, the relevant margins applicable to futures will also apply to options. On expiry if buyer of the option decides to continue his position, he will have to pay standard margins applicable to futures. A buyer of a call option will become buyer of futures and buyer of a put option will become a seller.
Exchanges, however, are optimistic. Mrugank Paranjape, MD & CEO, MCX said, "The approval for options is a very welcome development that will go a long way in deepening market participation and give another much needed risk management tool to participants."
Concurring with Paranjape's views, Samir Shah, MD & CEO, NCDEX said, "Options are a much better risk management tool for a large number of participants including farmers, who have started using futures actively as well. The combination of options and futures can give market participants the leverage of futures with the safety of options. With addition of liquidity through options, various associated benefits such as lowering of impact cost, improved market stability, and improved price discovery will also be seen."
However he agreed that the settlement process for commodity options will be a complex process initially.
Sebi had earlier decided to permit one agri commodity and one non-agri commodity for launching option trading. As of now there is no clarity on this, as detailed guidelines are being worked out.
Sebi after its board meeting issued a statement saying, "To enable commodity derivative exchanges to organise trading of 'options', the board has approved a proposal to amend the relevant provisions of Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012. Detailed guidelines for trading in 'option' on commodity derivatives exchanges will be issued by Sebi."
Most participants are anxiously awaiting final guidelines for options. However, sources said as per Sebi's initial internal discussions, "Options expire in a previous month before the relevant futures contract enters the near month. Another alternative discussed by the regulator with market participants was that exchanges would be given flexibility to decide when the option will expire, which could be a few days before expiry of the futures. however whenever options are exercised and not squared off before settlement date, the margin applicable on futures on the expiry date will apply to options converted in futures."
To prepare option buyers for paying margin, Sebi had suggested exchanges put in place an early warning signal for participants indicating to them the margin money they will have to pay when the options are exercised.
While all exchanges, brokerages and other participants are awaiting final guidelines on this, they know now that option volumes are unlikely to rise significantly. The market will need to time to understand the whole mechanism of settlement. Those buying options to hedge their positions, have to pay only the premium, which is also the extent to which their risk is confined. However the moment the option expires and becomes a future, the cost rises and hence, "eventually players may start squaring off options before the day of settlement or carry forward positions by buying next options contract in order to avoid settlement in futures. Only those who are willing to give or take deliveries will let the option devolve into futures," said an industry expert.
