Options trading in commodities has become increasingly popular among investors in India. It is a financial instrument that allows investors to hedge their risks and speculate on the future price movements of underlying commodities.
Trading options involve buying or selling the right to buy or sell a particular commodity at a predetermined price, known as the strike price, on or before a specific date, known as the expiry date.
Globally, there is extensive commodity options trading, with major exchanges including CME, NYMEX, LME, and ICE providing options on commodities like gold, oil, and industrial metals.
The Securities and Exchange Board of India (SEBI) regulates the options trading market in India. It has set guidelines and regulations to ensure transparency and fairness in trading. One of the key advantages of options trading is that it allows investors to participate in the commodities market without owning the underlying asset.
However, options trading can be complex and requires a thorough understanding of the market and trading strategies. Investors need to clearly understand the different types of options, such as call and put options, and the factors that affect their pricing. They also need to have a sound risk management strategy in place to minimise their losses.
Various online trading platforms in India offer options trading in commodities. These platforms provide investors access to various commodities, including gold, silver, crude oil, and agricultural commodities, such as wheat, soybeans, and cotton. Investors can also leverage advanced trading tools and analytics to make informed trading decisions.
What’s different in commodity options?
Commodity options, like stocks, are not traded on the spot but on futures. The same applies to each equity stock option you trade; however, regarding commodities, Gold options are based on MCX Gold futures rather than spot gold prices.
If you trade Nifty options, your basis is Nifty SPOT rather than Nifty Future. The COMEX gold price serves as the underpinning for MCX Gold Futures. Hence, what we are doing is trading a derivative of a derivative.
How do options work?
An option is a contract that grants the buyer the right, but not the responsibility, to purchase the underlying asset at a certain price on or before a specific date or sell it. People use options to generate money, speculate, and manage risk.
Let’s explore some of the trading strategies for options. These strategies may reduce risk while maximising results.
Investors employ this strategy while holding a short-term position in the stock and being neutral about the direction the stock may take.
This strategy is advantageous when the stock price significantly moves in either direction, generating big returns for the investor.
Using this approach, the investor is guaranteed a basic price even if the stock value drops significantly.
Bear Put Spread
Investors who believe the stock price may drop soon will use this technique. This approach minimises both gains and losses. This method’s potential may be constrained, but the premium required is also reduced, making it the ideal method for equities that are underperforming in the market.
Bull Call Spread
Investors who believe the stock price would only improve significantly a while ago utilise this vertical strategy. While the investor lowers the asset’s potential upside, he also lowers the net premium paid, making the entire scenario optimal.
Long Call Butterfly Spread
The investor is not required to hold two positions in the same stock to use this approach. The investor combines the bear and bull spread strategies with the call option. When the stock stays constant until expiration, the highest profit is earned. A loss may occur only when the stock declines at or below a lower strike.
This approach is appropriate for long-held stocks with a record of producing large profits. This approach is for long-held equities that have been generating significant profits. The trader may buy a put option out of the money and simultaneously write an out-of-the-money call option.
Investors adopt this strategy when they believe the stock price will likely remain in a range but are doubtful of the movement’s direction. Using this approach, a trader’s potential profit has no upper limit, but their potential loss is limited to the total cost of the two option contracts.
Although this strategy resembles a butterfly spread, it incorporates both options. With this approach, profit and loss are constrained within a range and based on the strike prices of the used options.
This strategy requires the investor to own a bear call spread and a bull put spread simultaneously. A trader may adopt this technique if they believe they will make a small premium.
Introducing options in the Indian commodities markets would boost market liquidity and participation. To manage price risk, producers, processors, traders, and exporters/importers have access to an online stock market platform. It gives producers a platform to hedge their bets per their perception of the pricing.
Thus, options trading in commodities offers a lucrative investment opportunity for investors in India. However, it is important to understand the risks and complexities involved and have a sound trading strategy. With the right knowledge and tools, investors can make profitable trades in the commodities market.