MCX launches option trading in gold

Multi Commodity Exchange (MCX)- the country’s largest commodity exchange has started gold option trading.

This is the first commodity options contract in India. SEBI as the regulator of the commodity exchanges allowed the MCX to launch of gold option contracts with 1 kg gold futures as the underlying asset. The lot size for gold commodity options would be Rs 30 lakh.

MCX is the leading commodity exchange with a market share of over 90 per cent. It is focused in gold, base metals, and energy.

Another commodity exchange – the NCDEX was allowed by the SEBI to launch options trading in guarseed. The NCDEX specializes in agriculture commodities.

Future trading in commodities were started in 2001 and notable initiatives came in 2003 when several commodities were brought for future trading.

The derivative instrument allows investors to enter into contracts (futures and options) to either buy or sell gold sometime in the future at a pre-determined price, thus allowing investors to hedge any volatility in the price of the metal, for a price. Though gold future trading was launched fifteen years ago, the volume is coming down.

Under Gold Futures there is a deal in which an individual agrees to take delivery of gold at a mutually decided upon date by making an initial payment, with the complete payment to be made as per an agreement.

Options usually also turn out to be cheaper than binding future agreements will help in the wider participation of investors in the realm of commodity speculation

In India, futures for commodities were launched in 2001 but options are launched only in 2017.


What is an option?

An option is a financial contract sold by one party (the option writer) to another party (the option buyer/holder), which gives the right, but not an obligation, to the buyer of the contract to buy or sell the underlying asset at a stated date and at a stated price.

While a buyer of an option pays the premium and buys the right to exercise his option, the writer of an option is the one who receives the option premium and therefore obliged to sell/buy the asset if the buyer exercises it on him.

Hence an option is a contract to buy or sell an asset at an agreed price at a specified time. Here, when an investor is buying an option, he just gets the right to buy or sell the specified or underlying asset (share, commodities, currencies etc) with conditions.

The agreed price under the option contract is called the strike price.

Benefit of options

Futures contracts are marked to market daily, resulting in a debit or credit for as long as the investor settle the trade. Whereas in options, there is no daily mark to market. This means that there is no daily loss (and gain) possibility under options.

The cost is lesser in options compared to futures contracts. Maximum loss can be upto the option premium of an option buyer, whereas returns can be high. In the case of futures, returns are high, and losses can be unlimited.

Call and put options

Options are of two types – Calls and Puts options:

Call option: “Calls” give the buyer (of the option or contract) the right but not the obligation to buy a given quantity of the underlying asset (shares), at a given price on or before a given future date.

As per the contract, the option writer has to provide the underlying shares in the event that the market price exceeds the strike price. due to the contractual obligation. An option writer who sells a call option believes that the underlying stock’s price will drop relative to the strike price during the life of the option.

Put option: “Puts” give the buyer (of the contract or option) the right, but not the obligation to sell a given quantity of underlying asset (eg. Shares) at a given price on or before a given future date.

A put option buyer is bearish on the underlying stock and believes its market price will fall below the specified strike price on or before a specified date. On the other hand, a put option writer believes the underlying stock’s price will increase about a specified price on or before the expiration date.

All the options contracts are settled in cash.

Further the Options are classified based on type of exercise. At present the Exercise style can be European or American.

January 16, 2018
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