17.1 – Commodity options, finally!
My first commodity trade was on pepper futures and this was sometime towards the end of 2005 or early 2006. Since then I’ve closely tracked the developments of the commodities market and the commodities exchanges in India. 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 around 2009, there was an attempt to introduce options in the commodity market. Needless to say, when I first heard about this, I was quite excited thinking 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 soon. Around June 2017, SEBI cleared the files to permit commodities options.
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 and what to look for in the commodities options market.
For those who are not too familiar about options, I’d suggest you start reading the module on Options here.
Just like futures, the options theory for commodities would remain the same. You have to just pay attention to logistics, and that’s the objective of this chapter.
17.2 – Black 76
One of the 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 Biocon. 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 we 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.
If one were to talk about the crude oil options, then you need to remember the following –
- The underlying for Crude oil option is Crude oil Futures
- The underlying for crude oil futures is the price of Crude Oil on NYMEX
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 difference between an regular option (with spot as underlying) and option on futures is the way in which the premium is calculate. For the former, the premium can be calculated by using a regular Black & Scholes model and for the latter a model called Black 76 is used.
The difference between these two models is the way in which the continuous compounded risk-free rate is treated. I will not get into the details at this point. But do remember this – there are plenty of Black & Scholes calculators online, so don’t be in a hurry to punch in the commodities variables in a standard B&S calculator to extract the premium value and Greeks. It simply won’t work ☺
17.3 – Contract Specifications
We still do not know how the exchanges will set up the framework for these options. However, we did take a look at the mock framework and I’m guessing it won’t be too different from that.
To begin with, exchanges may roll out Gold options, and would slowly but for surely introduce options on other commodities. Here are the highlight.
Option Type – Call and Puts
Lot size – Since these are options on futures, the lot size will be similar to the futures lot size
Order Types – All order types would be permitted (IOC, SL, SLM, GTC, Regular, Limit)
Exercise style – Options are likely to be European in nature
Margins – SPAN + Exposure margin applicable for option writing and full premium to be paid for option buying. A concept of devilment margin will come into play, I’ve discussed this towards the end
Last trading day (for Gold) – 3 days prior to the last tender day
Strikes – Considering one ‘At the money strike’ (ATM), there would be 15 strikes above and 15 strikes below ATM, taking the total to 31 strikes.
This is where it gets a little tricky. Equity option traders are used to the following ‘Option Moneyness’ convention –
- At the Money (ATM) Options = This is when the spot is in and around the strike. So in a given series, only 1 strike is considered ATM
- In the Money (ITM) = All call option strike below the ATM and all put option strikes above the ATM are considered ITM options
- Out of the Money (OTM) = All call option strike above the ATM and all put option strikes below the ATM are considered Out of the Money (OTM) options
However, the commodities options will introduce us to a new terminology – ‘Close to Money’ (CTM) and this is how it will work –
- ATM – The strikes closest to the settlement price is considered ATM
- CTM – Two strikes above and two strikes below ATM are considered CTM
- OTM and ITM – The definition remains the same as in Equity.
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.
Let’s quickly understand how the settlement works. Consider this example – Assume the DSP of a commodity is 100. Assume this commodity has a strike interval at every 10 points. Given this, let’s identify the moneyness of strikes –
- ATM = 100
- CTM = 80, 90, 100, 110, and 120. Note, we have included two strikes above and below ATM
- OTM = All Call option above 100 and all Put options below 100 are considered OTM and therefore worthless
- ITM = All Call options below 100 (including 80 and 90, which are CTM) are ITM, and all Put options above 100 (including 110 and 120, which are CTM) are ITM.
All long option holders which are ‘CTM’, will have to give something called as an ‘explicit instruction’. An explicit instruction will devolve the option into a futures contract. The futures contract will be at the strike. For example if I hold 80 call option, then upon an ‘explicit instruction’, the call option will be devolved into a long futures position at 80. I’m guessing the ‘explicit instruction’, will be tendered via the trading terminal.
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.
All ITM option, except CTM, will get automatically settled. You need to be aware that settlement in options market is by means of devolving the option into an equivalent futures position. If you are holding a non-CTM, ITM option and you wish not to settle this automatically, then you need to give a ‘Contrary instruction’. In the absence of which, the contract will be automatically settled by means of devolvement.
Now, the question is why would you not want to exercise an ITM option?
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. So, this is when you use the ‘Contrary instruction’, privilege and opt not to exercise your ITM option.
17.4 – Devolvement into Futures contract
So assume you have an ITM (including CTM) option, and upon expiry the option will be converted (or devolved) into a Futures position. Now, we all 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? Naturally, at the time of buying the option, I would not park additional margin anticipating that the option ‘might’ get devolved into a futures position.
To circumvent this, there is a concept of ‘Devolvement Margin’. I will cut through the technicalities and let you know what you should know and expect –
- Commodity options will expire few days before the first tender date of the futures contract. This means, there will be few days gap between the expiry of the futures contract and the options contract
- Few days before the options can expire, exchanges will conduct a ‘What if scenario’ and generates a ‘Sensitivity Report’ to identify strikes which are likely to be ITM and CTM
- For all such options, exchanges will start assigning ‘Devolvement Margin’, this means you will have to fund your account with enough margin money to carry forward the option position. Half of the required margin needs to be available a day before the expiry and the remaining half on the day of expiry of the options contract to convert the position to a futures contract.
For example, The Expiry of the Gold option contract is on 28 November 2017 and the futures contract expires on 5 December 2017. Half of the margin needs to be added to the account on 27 November and the remaining on 28 November - If you holding a deep ITM option, then the profits arising out of this position will be considered to offset a portion of the margins required
- Given the above point, the deeper the option, lesser would be the margin required. This also means CTM options will attract higher margins
- In simpler words, if you are holding a commodity option, and it’s likely to expire ITM, and you intend to carry to expiry, then you need ensure you bring in margin money as you approach expiry
- How much margin, expiry dates, tender date etc will vary based on the commodity
Here is a quick note on how the options position will be devolved.
| Option Position | Devolved into |
|---|---|
| Long Call | Long Futures |
| Short Call | Short Futures |
| Long Put | Short Futures |
| Short Put | Long Futures. |
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 information.
Stay tuned.
Key takeaways from this chapter
- Options on commodities will be on Futures as underlying
- One cannot use the regular Black & Scholes Calculator for identifying the premium and Greeks
- Black 76 is the model used for Options on futures
- Upon exercising the option devolves into a futures position
- CTM options are two strikes above and below ATM
- If a CTM option holder does not give an explicit instruction, then the option is deemed worthless
- An ITM option holder can give a ‘contrary instruction’, to choose not to exercise the option. You would opt for this if you know that the position is not going to be profitable owing to taxes and applicable charges
when it strart ???
It is expected to start by September’17 end as per MCX report. The first Commodity option derivative will be GOLD!
First week of October most likely.
http://www.moneycontrol.com/news/business/aim-to-launch-gold-options-trading-by-oct-1st-week-see-avg-daily-turnover-go-up-mcx-2371789.html
Not sure Madhav, hopefully sometime soon!
When will commodities options starts???
It is expected to start by September’17 end as per MCX report. The first Commodity option derivative will be GOLD!
Hopefully, sometime soon.
Wonderful, i can trade commodity options till 11:45 pm.
Well, the idea is to stay profitable 🙂
can we apply the same option theory and option strategy for commodity market?
Absolutely!
I have been waiting for this for many years because I know the huge opportunity for making fortune in short commodity future’s options, as the premium would be fat. I have the following questions though:
1. If I am short call/put options, can I square off the position anytime I want to or I have to wait for Expiry day (Because of european style options). If no then that means we have to carry losses without having an option to square off. That will be disastrous situataion.
2. Is it possible to square off short options in cash always as I don’t want my short options to be devolved into futures.
3. What will 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.
4. Do we have to open commodity account with Zerodha to trade commodity options.
1) You can square off anytime, no need to wait till expiry
2) Its best if you square off the position before the tender date and cash out
3) Exchanges work on robust framework, this is unlikely to happen
4) Yes, this is if you wish to trade through Zerodha.
Thank you Karthik!!!
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? or it means that only cash square off of ITM options are allowed and not devolvement of ITM options before expiry, I think the latter is most likely answer to my own question.
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..we should see how the final product would shape up.
Lets just hope we have good vibrant (liquid) capital markets in the coming days.
Hi Sir,
I read module many times but not able to understand completely,
But I think if you please explain in terms of Nifty I would understand better
I usually trade in nifty and banknifty options only
Let nifty spot is 10006 and nifty future is at 10020
I short call option [email protected]
On expiry nifty is at 9900
I would get 75*50,
If we imagine the above scenario to be traded just like what you explained, what I would get premium or future contract
Please explain
Thanks
Rohit, this is commodity options, they are structured slightly differently from Nifty options. I’d suggest you read this if you are interested in trading equity options – https://zerodha.com/varsity/module/option-theory/
Sir do u ve any idea about wat ill be d premium on gold ill be an average.. like 10k o below 10k.. pls do reply
No, no idea sir.
It was announced that the Gold options would start somewhere between 6th and 12th October. But it’s almost 10 October and there is no announcement yet?
Any news or idea if they are launching GOLD OPTIONS before Diwali or not?
Hopefully yes, I guess we have to wait and watch 🙂
It will start in next 8 days
Hopefully sooner!
gold options starts from which date sir.
17th Oct I guess.
Sir wen we will see zerodha starting eq an commodity trading by same acc
When SEBI comes out with a circular approving brokers to do this 🙂
But I think sebi has allow because I saw this on mcx’s wevsite Circular no.: MCX/MEM/386/2017 October 13, 2017
_________________________________________________________________________
Sub: Waiver of Admission/Transfer Fees – Integration of Broking Activities
Members of the Exchange are hereby notified that in order to encourage existing Members
of MCX/ Members of Equity Exchanges (duly registered with SEBI) to avail the facility of
Integration of Broking Activities, a waiver has been granted in Admission Fees/Transfer
Fees. Accordingly, the following amendments are made in the Business Rules of the
Exchange by inserting Business Rules 11.1 and 11.2 in Chapter 1 of the Business Rules of
the Exchange:
11.1 No Admission Fees/Transfer Fees shall be charged to the existing Members of
MCX/ Members of Equity Exchanges (duly registered with SEBI) applying for
new membership or transfers of membership through
amalgamation/merger/transfer, up to September 30, 2018, provided the
documentation and other processes are complete by the said date.
11.2 The waiver has been made applicable to Applications received after July 13,
2017 (i.e. the date on which SEBI allowed integration of Broking Activities).
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.
Vandana Vania
Sr. Manager – Membership
Kindly contact Membership Team on 022 – 6649 4080 or send an email at
[email protected] for further clarification.
——————————————————- Corporate office ——————————————–
Multi Commodity Exchange of India Limited
Exchange Square, CTS No. 255, Suren Road, Chakala, Andheri (East), Mumbai – 400 093
Tel.: 022 – 6649 4000 Fax: 022 – 6649 4151 CIN: L51909MH2002PLC135594
http://www.mcxindia.com email: [email protected]
Perhaps, maybe I need to update myself.
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?
Logically it should be DSP of the Option’s expiry day and not the future’s expiry day. Suppose gold’s DSP is 30050 then the 30000 CE of Gold should be 50 Rs ITM. and 30100 strike CE should expire worthless as OTM.
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.
Ex:One Call option of strike 29600 bought at 250Rs will devolve into a future position as if bought at 29600. You wud hv 3 days to close/rollover the future position.
I can’t see Gold options in Pi yet. Why is it not updated as the trading in Gold options is starting in 30 minutes @10am. and at 9:30 Zerodha (Kite and Pi) is not ready to offer this product. I was hoping that it will get updated in the securities master of Pi well in advance.
We will go live next week, Amarjeet. Meanwhile, I’d suggest you give your consent to trade MCX gold options here – https://zerodha.com/mcx-options/
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. How come it’s not enabled. And what is the procedure to enable it?
Done. I was able to successfully give consent for Gold options trading. Thank you.
NOW I AM WONDERING WHICH DAY NEXT WEEK WILL TRADING IN GOLD OPTIONS START??
No timeline yet, Amarjeet. Hopefully, very soon 🙂
I used to search google for about two years “gold options starting in mcx India”
Now I am searching Zerodha “Zerodha commodity options trading start”
It’s a long searching game. I hope will end soon!!!
Are you sure you were trading within us? If yes, then I don’t see how this could have happened. Will get this checked.
Oh no!!!
That time I logged in with my brother’s account details whose commodity account is not activated. I realized it later and then I logged in with my account and so….I could give consent easily then….wooooooos
Don’t worry, markets are full of opportunities!
Sir wat s d premium for gold
U can find the premium values at this mcxindia website link.
https://www.mcxindia.com/market-data/option-chain
Your question is not complete. It should be something like below:
1. What is the premium of gold futures to spot market?
or
2. What is the premium of 29700 Gold November Call?
etc.
For now you can track the premiums here – https://www.mcxindia.com/market-data/option-chain
Hi
How much premium is required to sell call option.
To sell options, you don’t need premium, you will need margins. 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://zerodha.com/margin-calculator/SPAN/
When is zerodha starting gold options? any approx timeframe?
It will be up sometime soon, Amit. Unfortunately, cant commit the timeline yet.
Dear sir, why I am not able to load Gold Option in my Pi Software, I can see MCX Fut only Please Tell me , Have i need to update any kind of Software ?
We have not started Gold options yet. Will start sometime soon. Meanwhile, please do give your consent to for MCX options – https://zerodha.com/mcx-options/
Sir,
Why zerodha kite or pi not getting MCX gold option contract for trading ? or please advice the script name.
Hi,
https://zerodha.com/margin-calculator/SPAN/ this doesnt list margins for Gold Options.
If you can tell apprx prices for option selling- it’ll be greatly helpful..
And there’s no volatility listed on https://www.mcxindia.com/market-data/option-chain , is that alright??
Will you release Greeks calculator for Black 76 too???
We’ve not yet started trading on Gold Option, Maddy. Black 76 is on the list of things to do. Btw, not much activity on Gold options on MCX.
Sir till brokers not start how can any volume come in gold options
Liquidity chases liquidity 🙂
Almost 2 weeks since Gold option started. How long do we have to wait to start trading?
Can’t comment on the timeline, Avanish. Also, you maybe interested to know that there is no liquidity (yet) on Gold Options – https://www.mcxindia.com/market-data/most-active-puts-calls
Option training in mcx have started?
Mcx Commodity Options Trading started?
Hopefully soon, hard to commit a timeline yet.
I have account in zerodha equity…if i want start trading in gold option then i have open account in mcx or will it ok on current account..
You will have to open a Commodity account online, check this – https://zerodha.com/?ref=varsity
are options on commodity available now to trade?
Gold options have started on MCX, will take it live on Zerodha soon.
What is the date by which Zerodha will be launching gold options?
We are testing the platform, Manik. Should be available sometime end of next month I guess.
hi
what will be the margin required to write Gold options call at strike price of 29800
Ah, not sure Venkat. But I’d suspect it would be similar to buying Gold Futures.
Has the MCX Gold option started on Zerodha?
Sorry, I cannot really commit a timeline yet.
Hi Karthik–can u share some successful trade setup strategies in commodity and also a detailed explaination.
Deepak, you can pretty much run the strategies being discussed here on Commodities as well – https://zerodha.com/varsity/module/trading-systems/.
What is the tentative start date of Gold Option trading at Zerodha. Its really been long time.
Hard to comment on this, Riukant.
Dear Karthik.
As usual awesome tutorial!!!! Could you just tell me the symbol name of Gold option?? So that i can keep it in the market-watch.
Glad you liked the content, Soumya. I’d suggest you type ‘Gold’, in Kite market watch, Kite will be prompted you to load the latest Gold contract.
Gold Option trading still not activated in kite.
Yes. By the way, the options are not liquid either on MCX.
Because Zerodha didn’t activate option trading! more than 20% volume generated by Zerodha Traders alone on MCX.
We are working on it, Ritukant!
4 months since gold option started. Very laid back attitude by Zerodha in starting option. Will check if other brokers ar offering gold option. If yes will not hesitate to switch.
Avanish, Gold options are live on our desktop software, Pi.
We are launching on Kite very soon
Make sure to sign the MCX Consent Form, if you haven’t already
I checked NCDEX and MCDEX but could not find any option chain. The gold option is illiquid. Why do you think commodity option has not taken off in India?
Lack of awareness is perhaps the single biggest reason. I think equity markets itself is still in its nascent stage, it will be a while for the commodities market to pick up full steam.
Thankyou for replying Karthik. Is there a way to play options in india on gold, crude, soybean and coffee?
Gold options are available on the exchanges, but unfortunately, there is not much activity there. No other commodity options are available.
Ok, karthick do you know any other instrument other than nifty, banknifty and stock options where options are liquid enough to write far-out-of the money calls/puts in india?
Along with the names you’ve mentioned, you can look at the top 5 names which constitute the index – like ITC, SBI, TCS, Reliance, and Infosys.
Sorry i mispelled your name
Ah, thats alright 🙂
Ah, thats alright 🙂
Am trying to trade crude oil options through kite / pi. However, when I place an order it rejects the order saying: RMS:Blocked for CRUDEOIL OPTFUT mcx_fo block type: ALL. Please clarify.
Have you given consent for MCX options to be enabled for your account?If not, do it here.
If you’ve already consented and still face the issue, please contact support
I have already given consent. I can see the contracts on both kite and pi. I have also contacted support. They say that zerodha has not activated crudeoil options which is hard to believe since I see that there is trading happening.
call zerodha
they send a link your mail id
you only click the mail and put your client id
Great job great
Happy learning, Sankar!
Please mention whether we have to square off put option position say 5 days before expiry otherwise it will be Physical delivery.
Because yesterday I received an email to square off my position but I wanted to keep that. This question is for contract which has physical delivery obligation. Also mention about other commodities settlement procedure.
It is best if you can square off the position before the expiry, Santosh.
Sir I want to know the exact rule. Since I called Zerodha call & Trade they told me to square off position before 11 pm otherwise settlement issue, I did. But I am not sure why he asked me to close ? Please mention exact rule. Want to leave my position in expiry let exchange settle, Ready to pay STT.
Santosh, we do not allow physical delivery of the contract due to operational limitations(Higher margin requirements, etc).
Therefore, you need to close your position or our RMS team will close the position 5 days before expiry.
If you want to continue holding the contract, why don’t you rollover the contract to the next month?
Hi Karthik,
Sorry not related to options topic but Other brokerages like Angel Brokerage, Tradejini are already allowing clients to use equity ledger as a common ledger for both Equity n commodity trading. When will Zerodha allow this? Only when NSE launches commodity contracts?
Best regards,
Kiran
Kiran, this requires few changes in the company structure. We are working on it.
how to know options expiry dates, on commodities?
In the Kite market watch, click on the market depth icon on the respective commodity options contract. You will find the expiry date of the contract there. Check this screenshot
In equity options there is a concept of implied volatile, but did not found in commodity options. so please let me know whether IV is not considered for commodity option. Is there any option price calculator tool is available for commodities?
All options, irrespective of their underlying assets have implied volatility.
So why IV is not shown in option chain on mcx website like it is shown for equities on nse website.
I’m really not sure, Rohit. Suggest you check this with MCX directly. Thanks.
Hi sir,
Now as the commodity options are being traded and so many changes occurred in it. It will be helpful if you update this COMMODITY OPTIONS segment.
Thank you
Yes, will do this shortly, Ashish.
Dear Sir,
I am big fan of Zerodha Varsity, I learned a lot reading this.
I have one question on Crude Oil option expiry –
1)
Could you explain in detail what is best way to square off short call/put positions?
For example, Crude Oil SEP 5100CE may be expired worthless (Current FUT PRICE = 4956Rs); expiry date of which is 17/09/2018, Monday. Short trade was initiated on 3rd Sep’18.
When should I square off this trade if I do not want to get trapped with any extra charge?
2) Plz explain explicit/contrary instructions with example, if possible.
1) I’d suggest you square off before the expiry date and not really wait for the expiry
2) I need to check on this, myself. But I guess this is the instruction to take physical delivery of the commodity, which we don’t support at Zerodha.
Thank you so much sir for quick reply.
I agree that we should square off before expiry date.
Still, I would like to know your view on this –
For bank nifty OTM strikes, we have expiry day strategies and strategies 2 days prior to expiry (options selling) to take advantage of time decay since OTM strikes will be worthless upon expiry.
Having said that, what will you suggest me (regarding squaring off to avoid any extra charge , to avoid devolving to future position if strike price comes out to be CTM) , if I initiate trade 2 to 3 days prior to options settlement date?
Here I am aware that Options settlement date is 3 business days prior to FUT expiry date.
Q-2, From where I can download daily closing price of crude oil future for last 2 to 3 years to calculate Average and SD?
Many Thanks!
You can always square off the position on the expiry day just before the market close i.e around 3:15 PM or so.
YOu can download this from Pi. Suggest you call our support desk for this. Thanks.