Futures Markets - Part 11: Options on Futures

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Futures commodities and options trading first commodity trade was on pepper futures commodities and options trading and this was sometime towards the end of or early MCX has done a tremendous job in promoting commodities market in India.

They have continuously introduced new contracts and enhanced the market depth. Liquidity too has improved many fold since then.

If I remember right, sometime aroundthere was an attempt to introduce options in the commodity market. Needless to say, when I first heard about this, I was quite excited thinking about all the possibilities that one would have trading commodity options.

But unfortunately, this never came through and the commodities options were never introduced in the market. Since then, this topic on commodities options has surfaced couple of times but each time, it just remained a market rumor. However, it now appears that options on commodities will finally hit the market sometime soon.

You can read the new article here. Since then commodities exchanges have been working hard to build a good futures commodities and options trading to introduce the commodities options.

Given this, I thought it would be good to have this quick note on what to expect and what to look for in the commodities options market. Just like futures, the options theory for commodities would remain the same. One of the important bits that you need to note with commodity options is that these are options on Futures and not really the spot market. For example, if you look at a call option on Biocon, the underlying for this option is the spot price of Biocon. Likewise, if you look at Nifty options, the underlying is the spot Nifty 50 index value.

However, if you were to look at an option on Crude Oil, the underlying here is not the spot price of Crude Oil. This is quite intuitive as we do not have a spot market for Crude Oil or for that matter any commodities in India. However, we do have a vibrant futures market. Hence the commodity options are based on the commodity futures market. So in a futures commodities and options trading, this can be considered a derivative on a derivative.

For all practical purpose, this should not really matter to you while trading. The only technical difference between an regular option with spot as underlying and option on futures is the way in which the premium is calculate. The difference between these two models is the way in which the continuous compounded risk-free rate is treated. I will not get into the details at this point.

We still do not know how the exchanges will set up the framework for these options. To begin with, exchanges may roll out Gold options, and would slowly but for surely introduce options on other commodities.

Here are the highlight. Lot size — Since these are options on futures, the lot size will be similar to the futures lot size. This is where futures commodities and options trading gets a little tricky. Settlement — For daily M2M settlement in Futures, the exchange considers the commodities daily settlement price DSP as the reference value. The DSP of the commodity on the expiry day will therefore be the reference value for the options series as well. Consider this example — Assume the DSP of a commodity is Assume this commodity has a strike interval at every 10 points.

An explicit instruction will devolve futures commodities and options trading option into a futures contract. The futures contract will be at the strike. Now, here is an important thing that you need to remember — If you futures commodities and options trading not give an explicit instruction to devolve your CTM option, then the option will be deemed worthless. You need to be aware that settlement in options market is by means of devolving the option into an equivalent futures position.

In the absence of which, the contract will be automatically settled by means of devolvement. There could be an instance where the ITM option that you have may not be worth exercising given the taxation and other applicable charges. So in this case, you are better off not exercising your ITM option rather than exercising it.

Now, we all know that a futures position requires margins to be parked with the broker. How do we account for this? I mean, when I go long on option, I futures commodities and options trading have to pay for the premium right?

I will cut through the technicalities and let you know what you should know and expect —. I guess as and when the option contracts roll out, we will have greater insight into the structure. I will updated this chapter when the commodity options roll out with the exact information.

First week of October most likely. I have the following questions though: If no then that means we have to carry losses without having an option to square off.

That will be disastrous situataion. What will be likelihood of the options been rigged off in the beginning? I am scared may be some big players take us for a futures commodities and options trading perticularly in the commencement months. Do we have to open commodity account with Zerodha to trade commodity options. Then why is it european style options. They both can be squared off any time. What do they mean that european style options can only be exercized on expiry?

Does that mean that ITM options of buyers can not be squared off before expiry? I am familiar with the equity options of NSE for a long time. And I am very comfortable with them. Now this beast comes up for which I am desparately waiting since announcement 2 years futures commodities and options trading. Almost daily I search for futures commodities and options trading option start date. But now it seems its nearby. Apart from the commodity options, there was a news about 6 months back about commencement of Cross currency futures and options.

But now it seems they are out of the basket of hope. Yup, its to do with devolvement I guess. Btw, this is just the draft. Rohit, this is commodity options, they are structured slightly differently from Nifty options.

Sir do u ve any idea about wat ill be d premium on gold ill be an average. It was announced that the Gold futures commodities and options trading would start somewhere between 6th and 12th October. Accordingly, the following amendments are made in the Business Rules of the Exchange by inserting Business Rules The above amendment in Chapter 1 of the Business Rules of the Exchange shall come into force with effect from the date of this circular.

Members are requested futures commodities and options trading take note of the same and ensure compliance. Hi Sir I am confused about last trading day and settled price, please help Which is last trading day it is 5th or 2nd of every month If it is 2nd, settled price of which date would be considered?

Last trading date would be 3 days prior to the tender date. For settlement, the exchange would consider the daily settlement price DSP. Actually Sir I was asking, If I sell one call option then final settlement would be according to which date settlement price? Looking at the handouts at mcxindia, Option contract will devolve into a futures position as if taken at the strike price of the Option contract. One Call option of strike bought at Rs will devolve into a future position as if bought at Why is it not updated as the trading in Gold options is starting in 30 minutes 10am.

I was hoping that it will get updated in the securities master of Pi well in advance. We will go live next week, Amarjeet. When I clicked on your above link I got a message that my commodity account is not enabled. I used to trade in commodity some months back. And what is the procedure to enable it? Are you sure you were trading within us? Will get this checked. I realized it later and then I logged in with my futures commodities and options trading and so…. I could give consent easily then….

U can find the premium values at this mcxindia website link. What is the premium of gold futures to spot market? What is the premium of Gold November Call? For now you can track the premiums here — https: Margins are dependent on futures commodities and options trading strike that you choose, but generally, it is about the same as the margin required for a futures trade.

Check this — https: We have not started Gold options yet. Will start sometime soon. Meanwhile, please do give your consent to for MCX futures commodities and options trading — https: Why zerodha kite or pi not getting MCX gold option contract for trading?

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Let me put a disclaimer out here from the start: Any attempt to have call options explained is not easy, and it normally takes a while it took me at least a week to fully grasp the concept of what a call option is, and what it represents.

There are many different types of options out there, and each one would require its own website worth of information to grasp each individual concept. That already sounds a little convoluted…see, I told you that it may take a few days to sink in. Think about it this way…if you were at a department store and you wanted to buy a DVD player that was on sale, but then you found out that the last one was sold before you had a chance to get to it, most stores will allow you to create a raincheck for that item.

The whole point of buying call options is that you expect the price to rise in the relatively near future. So if Corn is trading at For instance, as of this writing, with Corn trading at about Another HUGE benefit of buying call options is the fact that unlike buying the futures contract your risk is limited; with buying options, you can never lose more than your initial investment.

So with our Corn call option example Once you buy the option, your risk is set, and you now have the right to buy one Corn contract stock at the If Corn were to have a major spike in price and shot up to For example, if you were to buy a call option on Corn with a strike price of So, buying a Corn call option with a But if Corn were to have a dramatic and quick spike in price, and it jumped up to Nonetheless, I hope this little diddy on call options explained has at least begun to bring some clarity to this detailed area of investing.

If you understand the effect that volatility has on the options market, you will understand how sometimes extraordinary profits can be pulled from trading commodity options with very little relative investment. When you trade options, you are basically trading volatility, nothing more, nothing less. Remember the option is only going to be as stable as the futures contract that the option represents.

Volatility is basically reflected in the sharp rises and drops in option premiums, and the degree of fluctuation that those premiums experience. If you use it right, volatility can be your best friend. Once you understand a little about market psychology, you can truly exploit volatility to create some serious profits in a relatively short period of time. Before I get sidetracked, let me mention the fact that there are two types of volatility in commodity options trading and really all options trading for that matter: In other words, how stable or unstable have market prices been throughout history?

The basic reason why it is important to understand volatility is because it will tell you what your best plan of action is, as far as what type of position to take in the markets. In the realm of commodity options trading , you have to be prepared to face the uncertainties and volatility that the futures markets can throw at you. You have to keep in mind that options is simply a game of educated guesses.

It is vital for you to make that distinction before even beginning to enter a trade. The options markets are inherently speculative. The whole drama of it is the big question mark about what the markets may or may not do.

This is where you get volatility skews and parity in puts and calls. This is why option writers pad their premiums the farther out in months the options go, because they realize that the farther the timeline extends, the more probability there is for uncontrollable events to affect market prices. When this major drop in value happens, if you are wise, you will exit by offsetting your position instead of allowing your option to expire worthless.

This is an integral part of money management, which is probably the number one requirement for a person to successfully engage in commodity options trading ; you have to conserve your trading capital and not try to be some super-hero, willing to hock your house on a lucky chance.

Occasionally, they will get blown out by sudden market spikes or sell-offs, but at the end of the day, it is an art to recognize a truly undervalued option, and then be able to properly capitalize on trading it. In this blog we will go into various commodity options trading strategies , and learn how to recognize these opportunities in the markets when they present themselves.

One thing is for sure; with every trade, no matter if you come out with a profit or exit with a loss, you learn something. You pick something up. This, my friend, is some of what it takes to cut the mustard in trading commodity options. Leverage truly is a two-edged sword.

You must treat it with respect, and never be presumptuous or arrogant about the markets, as if you can always predict their movements.

I believe in using the widsom that God gave me to keep me from making a trading decision that would be thoroughly disatrous. I believe that taking a loss in trading commodity options can actually be part of a winning strategy. Live to trade commodity options another day.