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Gold Options Takes off with a Bang:  More Commodities are Lined up

Biren Vakil founder CEO of Paradigm Commodity Advisors

India has enriched history of indigenous customised desi version of derivatives; exchange should adopt and develop this time tested instruments. Let market have the choice of more customized indigenous products

After a decade long wait and brainstorming, finally option trading took off in India. Finance minister Arun Jetley has formally launched gold options to be traded at MCX. Market response was fairly satisfactory. On the first day of MCX gold options 5223 kg gold traded valued at around 1560 cr.  Volume in subsequent weeks little dried but still looks fairly better relative to a novice instrument. Once awareness about options becomes widespread and reaches to end users, including retail segment, options may garner depth and liquidity.  Option spreads are currently little wider and need to be finer to attract jobbers and delta geek players.  Moreover, risk premium is relatively low compare to implied and historical volatility. Hence, option sellers have less incentive to write the options.  For buy side and cash strapped participants cheap premium makes it low cost product. This instrument is especially useful for event driven trading . Every month certain key events like Nonfarm pay roll, PMI, housing starts and every alternate month fed meetings are lined up. Option traders could design front running or preamptive event centric strategies.

We need Indian touch, copycat products may be avoided

India has very rich and probably very old history of innovative derivative trading. During open outcry markets, ‘desi’ version of derivatives- jota and fatak- daily weekly and mudati (means European style last day settlement) were liquid. When i started career as a prop trader, i have extensively traded jota and fatak in Indore soy oil, surendranagar kapas, Bhabhar and Ahmadabad castor as well as equity derivatives in select stocks traded at Bhuj, Gujarat. Desi derivatives traded in 90s have daily, overnight and weekly time frames and also have some customized version like bhav farak jota bhavobhav jota. Such products have been tested and if introduced in legal form, it could generate immense response. It is worth noting that NSE bank nifty has weekly derivatives which expires every Friday and it is very liquid and successful product. Once gold option become liquid, exchange is keen to launch options in copper, cotton, Crude palm oil and other products.

Options:  An essential , low cost tool in modern treasury: commodity futures industry galore

Commodity futures exchanges were lobbying for options since last several years. However continuous upheaval, regime change, regulatory constraints such as merger between FMC and SEBI and numerous obstacles in futures trading such as ban and relisting, and falling volume and SEBI's cautious and conservative approach to dealing in uncharted territories might have caused the delay.

Options markets are essential risk management tool for modern treasury. Markets are becoming increasingly volatile and option is a proven low cost tool compared to futures.  Options are offering multiple advantages to different kind of stake holders in commodity ecosystem. It helps manage price risk for producers and supply side risk for consumers.  It also offers arbitrage opportunities arising out of short term market inefficiency and mispricing.  Professional traders having expertise in advance options trading  like delta neutral or gamma hedging or volatility play can make a professional carrier as option trader.

Gold options- A big leap forward toward  diverse and integrated derivative ecosystem

Indian commodity futures market in general and bullion market in particular have been passing from pathetic time. India is second largest gold importer, however derivative industry is in dire street due to hefty burden of services and levies like CTT, stamp duty etc.  Trading in other parts of Asia, especially in Singapore, Shanghai and Dubai is much cheaper hence many proprietary desk has shifted their operations to Dubai and other offshore markets.  Chinese futures industry is growing at a phenomenal pace. Singapore is also stealing volume from India in Nifty and some other benchmarks. Gold options may help bring back some of prop desk volume and especially may bring some new participants from end users.

 Jewellers and bullion importers can hedge their inventory risk through buying put option with low cost to pay only premium price without sacrificing upside gain. Through option trader can take advantage of price fluctuation and volatility expansion and contraction with limited risk with buying option. Option seller has unlimited risk but hedge their position with future contract. Gold Call option implied volatility for 28 Nov 2017 expiry is 5% and for Put option implied volatility 11%. This difference is due to currency factor and import duty factor. Implied volatility of Gold option of MCX is at par with COMEX gold option. Comex Gold option implied volatility is hovering around 10% on annualized basis.

Government is planning to formalize bullion trade and want to integrate physical and futures market. Various institutions are currently brainstorming to form a unified national spot exchange for bullion. At present physical bullion trade is opaque, less transparent and  pose above normal credit and counterparty default risk. An integrated bullion market with balanced leg in physical and futures will help options market and vice a versa. Vibrant spot market, efficient futures market and liquid option markets are complementary to each other and such a scenario would be highly conducive for vertical growth and expansion of markets.

(Author is founder CEO of Paradigm Commodity Advisors, A research boutique which provides risk management solutions and strategic consulting in major markets.)

Disclaimer: Views are personal and not the views of the publisher.