How Does Commodity Options Work?

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My first commodity trade commodity options trading how to do on pepper futures 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 commodity options trading how to do 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 commodity options trading how to do.

You can read the new article here. Since then commodities exchanges have been working hard to build a good framework to introduce the commodities options. Given this, I thought it would be good to have this quick note on what to expect commodity options trading how to do what to look for in the commodities options market.

Just like futures, the options theory for commodities would remain the same. One of commodity options trading how to do 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 Commodity options trading how to do.

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 commodity options trading how to do 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 sense, 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 commodity options trading how to do 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 commodity options trading how to do 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 it 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 the option into a futures commodity options trading how to do. The futures contract will be at the strike.

Now, here is an important thing that you need to remember — If you do 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 commodity options trading how to do 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 just 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 commodity options trading how to do.

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 commodity options trading how to do be likelihood of the options been rigged off in the beginning? I am scared may be some big players take us for a ride 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 back. Almost daily I search for commodity 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 options 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 to 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 commodity options trading how to do 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 account 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 the 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 options — https: Why zerodha kite or pi not getting MCX gold option contract for trading?

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I'm a huge fan of trading commodity options. And you should be, too. But there are some nuances when trading commodity options that you have to consider if you're going to move some capital away from equities. These 3 differences are the most important concepts to understand, as they can potentially change the way you trade these instruments.

If there is one thing to learn about options is that each contract will have a different implied volatility. You can visualize implied volatility over various strikes by looking at the volatility skew. Notice that as we go lower in strike, the implied volatility on each contract rises. This is because option traders are willing to pay up for "tail-risk" protection, and most hedgers in equities are fearful of downside.

Instead of a "skew" we now have a "smile. It comes down to the perception of risk. Equity investors are fearful of downside in equities. But in commodities like gold, oil, soybeans, and currencies the perception of risk is bi-directional. So when hedgers and speculators come out to commodity options, they fear strong moves in either direction.

This changes the strategy set used in commodity options trading-- iron condors become more attractive, as do ratio sales after extreme moves.

Single stock equities can be driven by upgrades, downgrades, earnings, FDA events, insider selling, holding updates, institutional rebalancing, intermarket correlation, same store sales This heightened risk produces higher potential reward-- and for those that want to get more conservative, trading indexes or index futures can mitigate that risk.

With commodity options, the risks that drive movement are quite different than what drives equities. It could be based off supply reports or interest rate changes by central banks. Because the risks are different, it can give you a way to diversify your trades against different risks.

This can be crucial when finding the best trades. Joe farmer needs to sell his soybeans. Spacely Sprocket company needs to hedge their Euro risk. ZeroHedge has to buy more silver to combat the manipulators. They look to buy stock in companies. Contrast that to gold and oil: From a structural standpoint, they aren't "investments. I see two possibilities heading into the summer months.

If we get the first scenario, then correlations will ratchet up among stocks and it will be a macro game again. If the second comes along, then summer volatility and liquidity in equities will dwindle. Either way, commodity options trading is definitly coming back into my trading arsenal for the next few months. I've put together an Iron Condor Trading Toolkit that gives you the case studies and training needed to be consistently profitable in the market.

Click Here to Get the Toolkit. Fear is In Both Directions If there is one thing to learn about options is that each contract will have a different implied volatility.

That means the tail risk can be on either side. Commodities Have Different Event Based Risk Single stock equities can be driven by upgrades, downgrades, earnings, FDA events, insider selling, holding updates, institutional rebalancing, intermarket correlation, same store sales Why is risk bi-directional? Because the motivations in the commodities market are completely different than stocks. What's going on right now