After a decade-long wait and brainstorming, option trading took off in India with Finance Minister Arun Jaitley formally launching gold options to be traded at the MCX. The market response was fairly satisfactory.
On the first day, 5,223-kg gold traded valued around Rs 1,560 crore. On the second day, the volumes indicated relatively finer bid-ask spread, signifying satisfying liquidity and depth. Buoyed by the initial response, the exchange is keen to diversify and launch more options in copper, cotton, and crude palm oil and other products.
NCDEX, the prominent exchange which is conducting agri futures, also plans to launch guar options soon. Mock trading for guar options has already begun. According to an exchange official, the Securities and Exchange Board of India (SEBI) has primarily identified six option products—three each to be traded at MCX and NCDEX. Apart from gold which is already on board, the other short-listed candidates for MCX options are copper and cotton. For the agri space, guar would be a flagship product, followed by soybean or soy oil.
Commodity futures exchanges were lobbying for options since past several years. However, continuous upheaval, regime change, regulatory constraints such as merger between FMC and the SEBI, coupled with numerous obstacles in futures trading such as ban and re-listing, and falling volume and SEBI's cautious and conservative approach to dealing in uncharted territories might have caused the delay.
Options markets are essential risk management tool for modern treasury. Markets are becoming increasingly volatile and options is a proven low-cost tool compared to futures. Options offer multiple advantage to different kinds of stakeholders in a commodity ecosystem. It helps manage price risk for producers and supply-side risk for consumers. It also offers arbitrage opportunities arising out of short-term market inefficiency and mispricing.
Gold options- A big leap forward toward diverse and integrated derivative ecosystem
Indian commodity futures market in general, and bullion market in particular, have been passing from pathetic time. India is the second largest gold importer. However, derivative industry is in dire street due to hefty burden of services and levies like the Commodities Transaction Tax (CTT), stamp duty, etc. Trading in other parts of Asia, especially in Singapore, Shanghai and Dubai is much cheaper. Hence, many proprietary desk has shifted their operations to Dubai and other offshore markets. Chinese futures industry is growing at a phenomenal pace. Singapore is also stealing volume from India in Nifty and some other benchmarks. Gold options may help bring back some of prop desk volume and also some new participants from end users.
Jewellers and bullion importers can hedge their inventory risk through buying put option with low cost to pay only premium price without sacrificing upside gain. Though option trader can take advantage of price fluctuations and volatility expansion and contraction with limited risk with buying option. Option seller has unlimited risk but hedge their position with future contract.
The implied volatility of gold call option for November 28-expiry is five per cent and that for put option 11 per cent. This difference is due to currency factor and import duty factor. Implied volatility of gold option of MCX is at par with COMEX gold option. Comex Gold option implied volatility is hovering around 10 per cent on an annualised basis.
The government is planning to formalise bullion trade and want to integrate the physical and futures market. Various institutions are currently brainstorming to form a unified national spot exchange for bullion. At present, physical bullion trade is opaque, less transparent and pose above-normal credit and counterparty default risk. An integrated bullion market with balanced leg in physical and futures will help options market and vice-a-versa. Vibrant spot market, efficient futures market and liquid option markets are complementary to each other and such a scenario would be highly conducive for vertical growth and expansion of markets.
(The author is founder CEO of Paradigm Commodity Advisors, a research boutique which provides risk management solutions and strategic consulting in major markets)
