Global Historical Perspective
Options have been around for more than four decades, with present-day options trading taking place first in April 1973 on Chicago Board Options Exchange (CBOE) on a limited number of New York Stock Exchange-listed equities. Later, Options on futures contracts were introduced at the CBOT in October 1982. Since then, Options have emerged as one of the most popular derivatives tools, for price risk management, clocking a spectacular growth worldwide.
Fast Forward to India
With the Securities & Exchange Board of India (SEBI) setting the stage for launch of Commodity Options in 2017, market participants are excited about this new product offering, which has all the potential to change the landscape of exchange traded commodity markets. Till date, the only instrument available for commodity price risk management has been the Futures. But that is all set to change once Commodity Options are launched. The combination of Futures & Options would offer hedging strategies to market participants (hedgers, farmers & investors) to protect themselves from unfavourable price moves & effectively hedge their risk exposure. Further, with the expected participation of financial institutions, it will add depth to the market and overall increase the efficiency of the price risk transfer mechanism.
Benefits to Investors, Hedgers & Farmers
• Since Options represent a form of price insurance, there will be no margin calls for Options purchasers for either buying a Call (which are commonly used to protect against rising prices) or Put (which are commonly used to protect against falling prices). Rather, the Option purchaser has to pay a one-time premium upfront to the Option seller, helping the purchaser knows how much he has to pay upfront and what is the maximum risk. Such benefits are not available in any other tool, and shall help the market participants protect themselves against adverse price moves. Also, the premiums payable are significantly low as compared to margins payable for Futures positions.
• Commodity Options would add to enhanced liquidity in the market, lower impact cost, improve price discovery, lower volatility along with increase market stability, and allow quicker information reflection in prices. Also, it would lead to reduction in ignorance about commodities trading, as farmers, hedgers & investors, will understand its benefits more easily.
• Further, farmers producing the right quality and quantity as per exchange contract specifications, would be encouraged to directly hedge on the exchanges using Options, Farmer Cooperatives such as NAFED, could also benefit from the same. What is needed however, is awareness creation through regular trainings at key agri-hubs, about the benefits of Options and how it can have a positive impact on their well-being. The government could even look at subsidizing a part of the option premium for farmers as done in some countries where such an experiment has been successful.
Summing up, commodity options are the need of the hour in India, as it will go a long way in helping risk mitigation for various market participants, even banks wherein they will be able to hedge their exposure to farm collateral using options. Farmer and hedgers stand out to gain the most, as volatility is the new norm of the day, and the primary consumers and producers of commodities are more interested in protecting their margins unlike the speculators whose interest lies in price direction and volatility. Lastly, coming of options will help markets offer longer-term contracts, adding further depth and liquidity and will also lead to the entrance of more professional players in the area of commodities. Happy days are ahead!
(The author is Chief Business Officer at Angel Broking and the article has appeared in The Financial Express on 5th May 2017)