Sebi approves options trading in commodity futures

New Delhi: Sebi today allowed options trading in commodities for deepening the market but permitted each exchange to launch these contracts for only one product initially, while asking bourses to follow robust risk management measures.

Putting in place strict eligibility criteria, Sebi said options could be launched on futures contract of only those commodities that are among the top five in terms of total trading turnover value of previous 12 months. Besides, the average daily turnover of underlying futures contracts of such a commodity in past one year should be at least Rs 200 crore for agricultural and agri-processed commodities, and Rs 1,000 crore for other commodities.

"The Commodity derivatives exchanges willing to start trading in options contracts shall take prior approval of Sebi for launching such contracts," the markets regulator said in a circular. Exchanges have been demanding for long that options trading in commodities be allowed. While Sebi had agreed to permit options trading last year itself, some legal requirements were holding back the move.

After hectic discussions, Sebi finally decided to allow options trading on futures contract of commodities rather than any commodity directly being allowed as an underlying security. So far, only futures trading was permitted on commodity bourses.

Sebi has also stipulated necessary guidelines with regard to the product design and risk management framework to be adopted for trading in options on commodity futures. Further, it has issued guidelines on settlement method, position limits and trading hours for options on commodity futures.

Besides, Securities and Exchange Board of India (Sebi) has allowed bourses to introduce European-style options, wherein positions can be settled only on the day of expiry. "Exchanges shall adopt initial margin models and parameters that are risk-based and generate margin requirements sufficient to cover potential future exposure to participants/clients in the interval between the last margin collection and the close out of positions following a participant/client default," the regulator said.

Earlier in April, Sebi's board had approved certain amendments to the Securities Contract (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012 to enable the commodity bourse to launch options trading. Welcoming the development, MCX Managing Director and CEO Mrugank Paranjape said, "Options definitely would complement the existing futures contracts and further bolsters price discovery process in Indian commodity market."

Options would attract the domestic hedgers from small to large to hedge on domestic exchanges, he said, adding that MCX awaits detailed guidelines for trading from the regulator. "It enhances economic efficiency in meeting operational and compliance obligations at the member level, potentially resulting in ease of doing business. The integration would also help in widening market penetration through greater financial inclusion for stakeholders across all market segments," he added.

Echoing similar views, NCDEX spokesperson said that options are a much better risk management for a large number of participants including farmers, who have started using futures actively as well. "The combination of options and futures can give market participants the leverage of futures with the safety of options. With addition of liquidity through options, various associated benefits such as lowering of impact cost, improved market stability, improved price discovery etc. will also be seen," the official said.

In market parlance, options contract is a derivative product that provides an investor the right to purchase, without any obligation to buy at the specified price or date. On the other hand, futures contract refers to purchase or sale of a particular commodity or any other financial instrument at a predetermined price at a specified time in the future.