Commodities Trading
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Powered by:. COM cnbctv18news. Commodity option contract, with futures contract as its underlying is similar to a stock, interest rate or currency futures contract.
A commodity option is a contract which gives the buyer the owner or holder of the option the right, but not the obligation, to buy or sell the underlying asset. As the option buyer has the right but no obligation with regards to buying or selling the underlying asset, while the option writer has the obligation in the contract.
Commodity Options in Indian Derivatives Market
To explain the concept though an example, assume an exporter wants to a buy huge quantity of a metal and he finalizes the deal at Rs 30,00,, by paying a token amount or a security deposit of Rs 2,00, to the seller. Similarly, individuals aiming to purchase a particular asset in the future can enter into a call option to lock in the price for future exchange. Traders engaging in future and option trading can be classified into the following types. Such individuals enter into futures and options contracts in the share market to reduce investment volatility concerning price changes.
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Locking in a price for transaction at a future date helps individuals realise relative gains if the price moves adversely with respect to a trading position assumed by a buyer. However, in case of a favourable fluctuation, individuals entering into a futures contract can incur significant losses. Such risk is mitigated in an options contract, as an investor can pull out of a deal in case of favourable price swings. Hedgers aim to secure their gains or expenditures in the future by entering into a derivative contract. Such traders are popular in the commodity market, wherein individuals try to secure an expected price of a particular item for a successful exchange.
Understand it with the help of a future and option trading example. A farmer can enter into a futures contract with a wholesaler to sell 50 kg of potato for Rs. On the day of maturity, if the price of potatoes falls below that level, the farmer successfully hedged his position to minimise the overall risk associated with trading in the future.
However, in case of a price rise in the potato market, a farmer stands to lose out on profits. Such losses can be offset through a put option contract, which gives the farmer a right but not an obligation to meet the conditions of a contract. Price rise on the other hand, allows the farmer to withdraw from the contract and sell the items in the marketplace at the prevailing price. Hedgers primarily opt for physical trade wherein the asset is exchanged upon maturity of the contract.
It is particularly popular in the commodity market, wherein physical trade is undertaken by producers and companies to keep the cost of raw materials at a fixed level. It ensures stability in the price levels in an economy.