MCX to launch gold options on Oct 17

Dhanteras is considered auspicious for investment and buying gold.

Options trading in commodities is set to be a reality, with the Securities and Exchange Board of India (Sebi) giving its nod to the Multi Commodity Exchange (MCX) for the launch of gold option contracts with 1 kg gold futures as the underlying asset.

MCX said on Tuesday it was targeting Dhanteras (October 17) as the launch date. The festival is considered auspicious for investment and buying gold.

The government had first allowed options in commodities in February 2015. Two years ago, the commodity regulator was merged with Sebi, paving the way for implementing options trading.

Another exchange, the National Commodity & 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.

The exchange is testing the risk management mechanism and other issues, according to sources.

Options trading in gold will not be allowed in any other variants such as gold mini. 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.

The settlement of options will be different from what happens in equities.

In equities, options are settled in cash, but in commodities, since settlement is also allowed in physical deliveries, options will also have that alternative.

Hence, all options on maturity will devolve into futures or become futures contract, if not squared off before the given time-frame.

After it becomes futures, all norms of futures will apply and then deliveries can also be given. An MCX circular notes in detail how options will be traded and how they will be settled.

When one buys options, he pays the premium quoted. And if the trend reverses, the maximum he loses is the premium paid, while the seller of option takes unlimited  risk.

Importing 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 will be who sells options.

According to the MCX circular, each option expiry will have at least 31 strike prices available, viz. 15 each for In the Money (ITM) and Out of the Money (OTM), and one At the Money (ATM).

These price ranges cover wide price movements during the contract time, but most liquidity and trading usually happen in ATM or price around which relevant futures are traded.

OTM means far away from the trading range, and ITM means within the range.

Each strike price will have different premiums and open interests based on market perception of how prices are moving.

Different types of trading strategies may be used to hedge risk as well as provide liquidity.

The seller of options could be banks or even financiers who invest money to get badla or earn money that is usually higher than normal interest rates.

Such financiers usually run options as the buyer hedges risk and is ready to forget the premium if the bet goes wrong.

However, the seller of options takes most risk and hence makes maximum money.

Photograph: Rupak De Chowdhuri/Rediff.com