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Investing in options may be suitable if you want to diversify your holdings outside of equities, bonds, and mutual fund investments. The quick price movement of options makes them appealing to traders looking to make fast profits.
On the other hand, commodity options act like stock options, but here, traders deal with commodities like gold, crude oil, etc., for options trading.
In 2017, the Securities and Exchange Board of India permitted commodity options trading in India, marking a significant milestone for the Indian commodity derivatives marketplace.
Although options help diversify your portfolio, they can also easily result in unlimited capital losses. This is why purchasing options might be more beginner-friendly.
In this article, we will talk about everything you need to understand about commodity options trading. So, sit tight and let’s begin!
What are commodity options?
Options are classified as derivatives because they provide the buyer, also known as the holder or owner of the instrument, with the right but not the obligation to purchase or sell the underlying asset. If the buyer exercises their right, the option seller is required to purchase or sell.
Commodity options are contracts for derivatives that give the instrument’s buyer the choice to purchase or sell the underlying futures. Commodity options differ from stock options in that they are based on future contracts rather than stocks.
Since this is an option contract, the buyer has to pay a premium to the seller to get it. If the buyer sees a lucrative opportunity, they may exercise the option. Otherwise, they can let it expire.
As a result, the buyer, in this case, has the right rather than being obliged to. However, when the buyer decides to execute the contract, the seller must meet that obligation.
India offers a wide range of commodity options for various goods. Produce like cotton, petroleum byproducts like natural gas, and precious metals like gold and silver.
Traders can trade commodities on the National Commodity and Derivatives Exchange (NCDEX) and the Multi-Commodity Exchange (MCX).
With the help of a commodity option chain, you may analyse the strike prices, premiums, volumes, open interest, implied volatility, and other information for each option.
For example, the MCX provides you with the MCX commodity option chain, which you may use to plan your strategy by choosing the right option type, strike price, and expiration date.
Advantages of trading commodity options in India
Cost-effectiveness
Compared to future contracts, commodity options are less expensive, provide significantly higher returns, and have a price-limited loss. If stop loss is not used in a futures contract, gains might be very low, and losses can be substantial.
No cost above the premium
Option buyers are exempt from maintaining mark-to-market margin calls because the premium for such contracts has already been paid.
This can be applied to hedging
In the commodities derivatives market, which can be rather volatile, experts see options as a way to protect one’s pricing risk by taking advantage of the market’s tendency to swing regardless of the direction.
This can be used as a diversification tool
Commodity options may help manage portfolio volatility and provide shock mitigation in times of significant cash market volatility due to market changes and stressful factors like inflation.
Disadvantages of commodity options trading
Market volatility
Since commodity prices can swing rapidly due to various factors like supply and demand, geopolitical events, and more, traders are exposed to significant risks of losses.
Leverage
This can be a boon and a bane for traders, as leverage may magnify gains and losses. This is why having a thorough knowledge of market dynamics is crucial to being a successful trader in commodity options trading.
Differences between commodity futures and options
| Criteria | Commodity options | Commodity futures |
| Meaning | Contracts giving the right, but not the responsibility, to purchase or sell underlying commodity futures at a pre-agreed cost and date | Contracts that oblige to purchase or sell underlying commodities at a certain price and date. |
| Risk | Limited for the buyer, unlimited for the seller | Unlimited for both parties |
| Profit potential | Unlimited for the buyer, limited for the seller | Unlimited for both parties |
| Liquidity | Lower than futures, as options are less traded | Higher than options |
| Flexibility | Higher than futures, as options can be exercised or not, based on market conditions | Lower than options, as futures have to be settled or closed out |
Conclusion
Commodity options trading offers traders a flexible, cost-effective way to benefit from price movements in underlying assets like gold or oil. Though risky if not managed properly, options provide high leverage and limited downside for buyers.
Retail participants can tap into the potential of this high-growth market segment in India by understanding key dynamics like premiums, strike prices, expiry dates, and options chains.
FAQs
There is no definitive answer to this question, as different strategies may suit different traders, markets, and risk profiles. However, some of the common commodity trading strategies are spread trading, index trading, trend following, and arbitrage trading.
Yes, commodity intraday trading is profitable if done with proper research, discipline, and risk management. Some of the benefits of commodity intraday trading are high leverage, low margin requirements, and diversification. However, it also involves high risks, such as market fluctuations and liquidity issues.
The best commodity for options trading in India depends on the trader’s preference, risk appetite, and market conditions. However, some of the most traded commodity options in India are gold, silver, crude oil, and natural gas.
Technically, there is no minimum amount required for commodity trading, as it depends on the type of commodity, the lot size, the margin requirement, and the brokerage charges. Traders should start with an amount that they can afford to lose and that suits their risk profile and trading goals.
Commodity trading is not easy, as it involves a lot of factors, such as supply and demand, market trends, geopolitical events, and technical analysis. However, commodity trading can also be rewarding, as it offers opportunities to diversify, hedge, and profit from volatility in the commodity markets.
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