The Multi Commodity Exchange (MCX) has received the Securities and Exchange Board of India's (Sebi's) approval for the launch of gold option contracts with 1 kg gold futures the underlying commodity. In a circular, the exchange said that the date for launching options in gold would be announced separately but traders expect it to start trading around Diwali time.
The government had first allowed options in commodities in February of 2015. Two years back, the commodity regulator was merged with Sebi, paving the way for implementing option trading. Another exchange, the National Commodity and Derivatives Exchange (NCDEX), has also received approval from Sebi to launch options in guar seed, which is among the most traded commodities in the NCDEX portfolio.
Allowing options on 1 kg gold futures as underlying means option trading will not be allowed in any other variant such as gold mini and so on. Two types of options – call and put – will be available. Buying a call option means the buyer expects prices to go up and buying a put option means the buyer sees prices falling. In both cases, if the expectation of price movements comes true, the premiums for options go up and the buyer benefits. Exactly the reverse happens in selling options.
When buying options, a person pays the premium quoted. If the trends go in the reverse, the maximum he or she loses is the premium paid. However, the seller of options takes the unlimited risk of mark-to-market premium loss.
Import banks and agencies, as well as traders and Jewellers who take gold loans or buy gold to sell jewellery, can buy options to hedge their price risks. The key would be who sells the options.
Each option expiry shall have minimum thirty one strikes available — fifteen each for In the Money (ITM) and Out of the Money (OTM), and one At the Money (ATM). This price range covers wide price movements during contract time but most liquidity and trading usually happens at ITM or the price around which relevant futures are traded. OTM means far away from trading range and ITM means within trading range.
Unlike equity options, settlement procedures for commodity options are cumbersome. The MCX circular said, "On expiry of options contract, the open position shall devolve into underlying futures position. Long call position shall devolve into long position in the underlying futures contract. Long put position shall devolve into short position in the underlying futures contract. Short call position shall devolve into short position in the underlying futures contract. Short put position shall devolve into long position in the underlying futures contract. All such devolved futures positions shall be opened at the strike price of the exercised options." The circular had prescribed a detailed mechanism for various strike price options settlements.