What is a commodity futures option contract?

It is similar to a stock, interest rate or currency futures contract. It refers to buying or selling an underling at a preset price for delivery at a future date. That way you lock in a buy or sell price. It is mainly a tool to hedge. In the case of options, a seller buys a put option and a buyer a call option to lock in the price.

How does it help?

Say you have to buy 10 mt of rice by the end of Feb on the spot market. Your fear is price of rice may rise from current level of say Rs 20,000. So you buy a rice futures contract (10 mt) expiring on Feb 20 at Rs 20,000. If by the expiry spot rice rises to say Rs 21,000, you square off the contract and make a gain of Rs 1,000. On the physical market you buy rice for Rs 21,000.
So the rise in the physical market is offset by the gain on the futures market. In case of the seller, who sold the contract for Rs 20,000, Rs 1,000 loss on the futures market is offset by the gain on the physical market when he sells rice for Rs 21,000.

What about options?

In the above instance, a buyer will buy a call option and seller will buy a put option from an option writer. A seller can also sell the buyer a call option. However, Sebi is yet to introduce the final framework on options.  

What contracts are traded on the exchanges?

There are three functional national level commodity exchanges. MCX is the countrys largest metals and energy exchange followed by NCDEX which is Indias largest agri-exchange. NMCE, the oldest, offers futures on plantation products, like jute. MCX offers trading in gold, silver, crude, copper, etc. NCDEX in refined oils, oilseeds, spices, wheat and sugar.

Who are the participants?

In agri futures they are stockiest, wholesalers, trading companies, arbitrageurs and speculators. In gold and silver, jewelers, bullion dealers and speculators.

Is the role of speculators important?

Yes, because they take on the risk that hedgers seek to cover themselves against. For e.g., if an oilseed refiner sells a soya oil contract for next month at, say , Rs 70 a kilo to lock in that price. On the other side, there has to be a buyer who takes an informed decision that the price will rise above Rs 70. So he buys at that price.
If soya oil falls to Rs 65 by the contract expiry, the seller can still sell for Rs 70, gaining Rs 5. The buyer, on the other hand, has to buy it at that price, losing Rs 5.However, over-speculation is something regulators employ various tools to guard against.

Different types of commodities traded

World-over one will find that a market exits for almost all the commodities known to us. These commodities can be broadly classified into the following:

  •  Precious Metals: Gold, Silver, Platinum etc
  •  Other Metals:Nickel, Aluminum, Copper etc
  •  Agro-Based Commodities:Wheat, Corn, Cotton, Oils, Oilseeds.
  •  Soft Commodities: Coffee, Cocoa, Sugar etc
  •  Live-Stock: Live Cattle, Pork Bellies etc
  •  Energy: Crude Oil, Natural Gas, Gasoline etc .
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