Commodity Options :

Gold, Crude, Copper, Silver

WHY OPTIONS?

An option contract offers the best of both worlds. It will offer the buyer of
the contract protection if the price of the underlying moves against him but
allows him to walk away from the deal if the underlying price moves in his
favour.

Options:

• Give buyer the “right”, but not the “obligation”

• To buy or to sell an agreed amount of underlying asset (Notional
Value)
• On or before an agreed future date (expiry date)
• At an agreed exchange rate (Strike Price)
• In exchange for fee (Option Premium)
Call Option

• A call option gives the buyer, the right but not the obligation
to buy specified quantity of the underlying asset at the set
strike price on or before a specified date.

• The seller (writer) however, has the obligation to sell the

underlying asset if the buyer decides to exercise his option to
buy.
Put Option

• A Put option gives the buyer of the option the right but not
the obligation to sell specified quantity of the underlying asset
at the set strike price on or before a specified date.

• The writer of the option however, has the obligation to buy

the underlying asset if the buyer of the put option decides to
exercise his option to sell.
WHAT ARE OPTIONS?

• An option is the right, but not the obligation, to buy or sell a futures contract & buyer of an
option acquires this right.
• Commodity Call Option : Buy asset (futures contract) in the future at a pre-determined
decided rate today.
• Commodity Put Option : Sell asset (futures contract) in the future at a pre-determined
decided rate today.
OPTION TERMINOLOGY

• Option price: Option price is the price which the option buyer pays to
the option seller. It is also referred to as the option premium.

• Expiration date: The date specified in the options contract is known as

the expiration date, the exercise date, the strike date or the maturity.

• Strike price: The price specified in the options contract is known as

the strike price or the exercise price.

• European options: European options are options that can be

exercised only on the expiration date itself.
Some terms unique to options trading

• In the Money for Call Option: Futures contract value is above

strike price
• In the Money for Put Option: Futures contract value is below strike
price
• At the Money: Futures contract value equals strike price
• Out of Money for Call Option: Futures contract value is below
strike price
• Out of Money for Put Option: Futures contract value is above
strike price
• Open interest: The total number of options contracts outstanding or
open in the market at any given point of time.
 FACTORS AFFECTING OPTION PRICES
Implied Volatility Futures Direction (View)
• How much does the Futures move? • Which direction is the Futures likely
• More Futures fluctuation >> Option to move?
more likely to be exercised >> • Expected favourable Futures
Higher risk >> Higher Price movement >> Option more likely to
be exercised >> Higher Risk >>
Time Higher Price
• How much time left for the Futures to
Tail Risk
move?
• More time left >> Option more likely to • Hugely ITM or OTM Options are
be exercised >> Higher Risk >> Higher costlier than theoretical values
Price

Strike Rate
• What is the rate that the Option
becomes effective?
• Strike Rate closer Forward Rate >>
Option more likely to be exercised >>
Higher Risk >> Higher Price
Option Strategies

Call Option Put Option

Buy Call Sell Call Buy Put Sell Put

(Bullish) (Bearish) (Bearish) (Bullish)

Unfixed Gold Inventory Inventory Unfixed Gold

Premium Low Premium High

Premium Low Premium High
HOW ARE OPTIONS DIFFERENT FROM
FUTURES?
Futures Contracts Options Contracts
• Definition • Definition
An agreement to buy or sell an underlying An agreement which gives the buyer the right but not the
on a certain date and at a certain price, in
the future. obligation to buy or sell an underlying at a certain price on or
before a certain date.
• Obligation
Buyer and seller are both obligated to • Obligation
honor the contract upon expiry. Only seller is obligated to honor the contract on expiration.
• Margin Account • Margin Account
Both parties need to maintain a margin. Only option writer/seller maintains a margin.
• Advance payment/Contract pricing • Advance payment/Contract pricing
No, except the initial margin Requires upfront fixed premium from the buyer.

• Risks • Risks
Both buyer and seller have unlimited risk Option buyer has limited risk; Option writer/seller has unlimited
risk
BENEFITS OF COMMODITY OPTIONS

BENEFITS TO INDUSTRY/CORPORATES

• Options trading will make the commodities market robust and efficient.

• The combination of Futures and Options can give participants the benefit of price
discovery of Futures and simpler risk management of Options.

• The premiums on options are much lower, sometimes a quarter of the initial
margins paid on futures contracts.

• Hedgers can use option contracts where there is no further outgo after the initial
payment for the option premium.

• Risk for options buyer is limited to the premium paid

PARTICIPANTS AND THEIR PAY-OFFS IN OPTIONS
MARKET

PARTICIPANT PROFIT (Upside potential) COST (Downside potential)

Unlimited (to the extent of increase Limited (to the extent of premium
Call holder/buyer
in price above strike price) paid)
Practically unlimited (to the extent
Limited (to the extent of premium
Put holder/buyer of price of underlying becoming
paid)
zero)
Limited (to the extent of premium Unlimited (to the extent of increase
Call writer/seller
received) in price above strike price)
Limited (to the extent of premium Practically unlimited (to the extent of
Put writer/seller
received) price of underlying becoming Zero)

Unlike an option holder who has a limited risk (the

cost of the option premium) but practically unlimited
potential for gains; an option writer is exposed to
practically unlimited risk with limited gains (to the
extent of option premium received).
 FACTORS INFLUENCING OPTIONS PRICES (BLACK -76
MODEL)

Factors Increase Decrease

Call Prices Put Prices Call Prices Put Prices
Will Will will Will
Underlying Price

Time until Expiration

Volatility

Interest Rates

Strike Price
Commodity Options details
Options Details Gold Crude Oil Copper Silver

Launch date 17th Oct.17 15th May.18 21st May. 18 24th May.18
Strike Interval 100 50 5 250
Number of strikes 15,-1,-15 7,-1-,7 7,-1-,7 10,-1,-10
Number of Call & Put 31 CE & PE 15 CE & PE 15 CE & PE 21 CE & PE

Market Lot 100 100 1000 30

Tick Size 0.5 0.1 0.01 0.5
Tick Value 50 10 10 15
3 days prior to 2 days prior 2 days prior 3 days prior
1st tender day to expiry of to expiry of to 1st tender
Expiry day of futures futures futures day of futures
Future Expiry 5th June 19th June 29th June 5th July
Option expiry 29th May 15th June 27th June 27th June
 Settlement Mechanism

Settlement Mechanism of Commodity Options

ITM (In the money) Devolve into futures

Devolve into futures only

CTM (Close to money) on instructions
OTM (Out of the money) No devolvement
 Options Costing
Business Development Details
Particular Gold Silver Crude Oil Copper Zinc
Trading Lot 1 Kg 30 Kg 100 bbl 1MT 5MT
Price* 225 700 160 11 4

Turnover (Premium
Buy & Sell) 45000 42000 32000 22000 40000
Per Rupee Movement 100 30 100 1000 5000

*Please insert latest

prices of premium
 Options Costing
Costing Details
Gold Silver Crude Oil Copper Zinc
Particular Cost per lac Amount Amount Amount Amount Amount
Transaction Charge (Nil upto
sept. 18) 0 0 0 0 0 0
SEBI charges (Rs 0.15 /
lac)+GST 0.177 0.07965 0.07434 0.05664 0.03894 0.0708
STT (Rs. 50 /lac) only on sell
side premium 50 11.25 10.5 8 5.5 10
Stamp duty (Rs. 1 Lac) of
premium turn over 1 0.45 0.42 0.32 0.22 0.4
Brokerage 0 0 0 0 0
GST on brokerage (18%) 18% 0 0 0 0 0

Total Cost 12 11 8 6 10
 Gold Costing
Devolvement costing Call Put
Buyer Seller Buyer Seller
Gold Future price 30000
Premium price 300

CTT on exercise of options

@0.0001 of FSP (only for Rs.
purchaser) 0.10/lac 3 3
Devolvement of options
into futures @0.01% of
Short position Rs. 10/Lac 300 300
If buyer squares off
devolved position (CTT on
short position) Rs. 10/Lac 300 300
 Crude Oil costing
Devolvement costing Call Put

Buyer Seller Buyer Seller

Crude Oil Future price 4500

Premium price 45

CTT on exercise of options

@0.0001 of FSP (only for
purchaser) Rs. 0.10/lac 0.45 0.45
Devolvement of options into
futures @0.01% of Short
position Rs. 10/Lac 45 45

If buyer squares off devolved

position (CTT on short position) Rs. 10/Lac 45 45
 Copper Costing

Devolvement costing Call Put

Buyer Seller Buyer Seller
Copper Future price 450
Premium price 4.5

CTT on exercise of options @0.0001

of FSP (only for purchaser) Rs. 0.10/lac 0.45 0.45

Devolvement of options into

futures @0.01% of Short position Rs. 10/Lac 45 45

If buyer squares off devolved

position (CTT on short position) Rs. 10/Lac 45 45
EXAMPLE – HEDGING STRATEGIES

• Options represent a form of Price Insurance, cost of which is

the Option Premium determined during its trading by markets
• Improves market Liquidity, Transparency
• Maximum Loss to the extent of Premium paid for Buyer
• Possible apportioning of Hedging cover as may be needed

Basic hedging strategies:

Call or Put Protection Buying Puts ( for metal
Buying Calls ( for metal consumers having bought Fixed
consumers having bought Gold from Banks, Importers,
Unfixed Gold from Banks , Wholesalers etc)
Importers , Wholesalers etc)
OPTION STRATEGY FOR BULLION DEALER: PROTECTING
INVENTORY – FIXED GOLD

Bullion Dealer: Risk of

depreciation in Gold
(CMP 30000)

Buy Put option:

Strike price 30000
Prices Premium Rs.300 Prices go
go up down

Profit: Actual loss is

Loss: Maximum up Compensated by
to Rs.300 appreciation in the
premium price
The loss is limited to the extent of the premium paid i.e. Rs. 300/= & no MTM
EXAMPLE: PROTECTING INVENTORY – FIXED GOLD

Buy Put option : Strike price 30000 Premium Rs.300

P&L Payoff at Expiration Matrix (Premium: 300) 300

Underlying Price Payoff from Physical Net

At Expiry options Stock Profit/Loss 200

29500 200 -500 -300

100
29600 100 -400 -300
29700 0 -300 -300 0
29500 29600 29700 29800 29900 30000 30100 30200 30300 30400 30500
29800 -100 -200 -300
-100
29900 -200 -100 -300
30000 -300 0 -300 -200
30100 -300 100 -200
30200 -300 200 -100 -300

30300 -300 300 0

-400
30400 -300 400 100
Payoff from options Net Profit/Loss
30500 -300 500 200

Having hedge through options Bullion dealer protect himself against downside risk and also avails opportunity
profit if prices go beyond 30300/- in physical markets
OPTIONS STRATEGY FOR JEWELERS: BUYING UNFIXED
GOLD

Exporter : Risk of
appreciation in Gold
post receiving order
(CMP 30000)

Buy Call option

Strike price 30000
Prices
Prices go Premium Rs.300
go up
down

Profit: Actual loss is

Loss: Maximum up Compensated by
to Rs.300 appreciation in the
premium price
The loss is limited to the extend of the premium paid i.e. Rs. 300/- & no MTM
EXAMPLE : BUYING UNFIXED GOLD

Buy Call option Strike price 30000 Premium Rs.300

300 300
P&L Payoff at Expiration Matrix (Premium: 300)
200 200
Underlying Payoff from Net
Physical Stock
Price At Expiry options Profit/Loss
100 100
29500 -300 500 200
29600 -300 400 100 0 0

29700 -300 300 0

-100 -100
29800 -300 200 -100
29900 -300 100 -200
-200 -200
30000 -300 0 -300
30100 -200 -100 -300 -300 -300

30200 -100 -200 -300

-400 -400
30300 0 -300 -300
Payoff from options Net Profit/Loss
30400 100 -400 -300
30500 200 -500 -300
Having hedge through options Jeweller protect himself against upside risk and also avails opportunity profit if
prices break below 29700 in physical markets
OPTIONS TRADING STRATEGIES

STRADDLE: BULL CALL SPREAD:

Simultaneously buying of a put and a call of Buying a call option at a particular strike price
the same underlying, strike price and and simultaneously selling a call option at
expiration date. higher strike price of the same underlying and
Used when anticipating a price swing but expiration month. Used when one is
direction of swing not known. moderately bullish.

STRANGLE: BEAR PUT SPREAD:

Simultaneous buying of out-of-the-money put Buying a put option at a particular strike price
and out-of-the-money call of the same and simultaneously selling a put option at
underlying and expiration date. Works best lower strike price of the same underlying and
when underlying price moves sharply in expiration month. Used when one is
either direction. moderately bearish.
BENEFITS - AMENDMENTS TO SECTION 43(5)

• The Finance Act, 2013 has removed this anomaly and provided for coverage
of commodity derivatives transactions undertaken in recognized commodity
exchanges too under the ambit of Section 43(5) of the Income Tax Act, 1961,
on the lines of the benefit available to transactions undertaken in recognized
stock exchanges.

• Hedgers are no longer forced to undertake physical delivery of commodities

in order to prove that their transactions are in the nature of hedging and not
‘speculation’. This is clearly a great impetus for the growth of the commodity
derivatives market in India.
THANK YOU

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