Settlement rules on commodity options soon

No cash settlement here, expired options devolve into futures; Sebi still working out details

The Securities and Exchange Board of India (Sebi) on Wednesday approved trading in commodity options. 

Actual trading in commodity options will take some time to start as the finance ministry will have to amend the relevant rules, which can be done by issuing a notification. The Securities Contracts (Regulation) Act empowers Sebi to allow commodity options, however, the settlement of commodity options is more complex than equity options.

“Options will expire and devolve in futures the same commodity and not cash settlement like in equities,” Sebi Chairman Ajay Tyagi said, adding details for this were being worked out. 

Once a commodity option expires if the buyer of the option decides to continue his position he will have to pay standard margins applicable in the futures segment. A buyer of a call option will become buyer in the futures segment and buyer of a put option will become a seller in the futures segment.

“The approval for commodity options is a welcome development that will deepen the market and provide another risk management tool to participants,” said Mrugank Paranjape, managing director and chief executive officer of Multi Commodity Exchange of India. 

“Options are a better risk management tool for a large number of participants, including farmers, who have started using futures. The combination of options and futures will provide market participants the leverage of futures with the safety of options,” said Samir Shah, managing director and chief executive officer, National Commodity & Derivatives Exchange.  Associated benefits like a lowering of the impact cost and improved market stability and price discovery were likely, he added.

Sebi had earlier decided to permit one farm and one non-farm commodity for options trading. The industry expects commodity exchanges will be allowed to launch commodity options in both the farm and non-farm categories.

“To enable commodity derivatives exchanges to organise trading of ‘options’, the board has approved a proposal to amend the relevant provisions of the Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012,” a Sebi statement said after its board meeting. 

Sources said according to initial discussions within Sebi, exchanges would be provided the flexibility to decide when an option would expire. However, if an option is exercised and not squared off before the settlement date, the margin applicable in the futures segment will apply to the option. 

Sebi has asked exchanges to put in place an early warning signal to prepare option buyers about paying the margin.

Exchanges, brokerages and other market participants are awaiting the final guidelines. The market will need time to understand the settlement mechanism. 

Those buying options to hedge positions have to pay only the premium. Once an option moves to the futures segment, its cost rises and players may start squaring off options before the settlement date or carry forward their positions by buying the next contract to avoid settlement in futures.

Options available

• Changes in rules for options expected to be notified soon 

• Options trades that are not squared off will become futures, or could be settled by delivery

• Options that devolve into futures on expiry would require margin payment

• Options expiry likely to be few days ahead of futures expiry 

• Sebi may allow options in one agri and one non-agri commodity for starters