18.14 Commodity options market

The commodity options market is simply a market in which producers may purchase the opportunity to sell or buy a commodity at a certain price. We have already discussed the concept of option in our derivative segment. There are really two separate commodity options - one to insure products being sold against price declines, and another to insure products purchased against price increases.

Purchasers in these options markets have the “opportunity” but not the “obligation” to exercise their agreement. Therefore, the markets are appropriately named “option markets” since they deal in an option, not an obligation. For instance, if one desired to buy the right to sell corn for Rs 80 per bushel, the commodity options market provides the opportunity. By paying the market determined premium, one could then collect on the option if prices are below Rs 80 per bushel when the corn would actually be sold. If prices are higher than Rs 80 per bushel, the corn could be sold for the higher price and the cost of the premium is absorbed.

As mentioned, the call option gives the holder the right, but not the obligation, to buy the underlying commodity from the option writer at a specified price on or before the option’s expiration date. The put option gives the holder the right, but not the obligation, to sell the underlying commodity to the option writer at a specified price on or before the option’s expiration date.

However, in India, the Parliament passed Forward Contracts (Regulation) Act, 1952 and section 19 prohibits options trading in goods. No exchange or no person – whether he is a member of any recognized association or not – can organize or enter into or make or perform options in goods; it constitutes cognizable offence which is punishable under section 20(e) of the Act. Therefore, options are not covered in detail here.

Further reference:

For further information about commodities the following sites are useful.

www.fmc.gov.in

www.ncdex.com

www.mcxindia.com

www.icexindia.com

www.commodityindia.com

www.cmegroup.com

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