InvestorQ : What are some of the critical points that I need to understand about commodity options?
Mahima Roy made post

What are some of the critical points that I need to understand about commodity options?

Anamika Sodhani answered.
2 years ago

Commodity options have just about started in India but they have been around in other parts of the world for a long time. Here are some key characteristics.

Firstly, settlement will be slightly different in case of options. In case of commodity futures when you choose delivery in spot, then it has to be intimated to the exchange well in advance. In case of options, if the options are not closed then they automatically devolve into futures with the stroke price as the futures price.

Secondly, what effectively happens in this case is that if you are holding on to a long call or a short put position, then it devolves into a long futures position. On the other hand, if you holding a long put or a short call position, then it devolves into a short futures position.

Thirdly, all commodity options will have to be necessarily European in nature. They can only be exercised on the settlement date. Like in case of equity options, you can square up your positions in case liquidity is available. But if it is not squared up then it automatically devolves into equivalent lots of futures.

Fourthly, there is one more difference between F& O expiry in equities and in commodities. In case of equity markets, the futures and options will all expire on the same day. But, in case of commodities, the options will expire a few days ahead of futures to provide for the devolvement of options into futures.

Fifthly, there are two very important things to remember here. Once the options devolve into futures then the normal margins that are applicable to the futures position will start to apply. Hence option buyers, who have just paid the option premium till now, will now have to pay up the normally applicable margin on futures. Secondly, the settlement leads to devolvement of long calls and short puts into long futures. This is actually a mismatch because the intent of the buyer of the call and the seller of the put are entirely different.

Commodity markets have seen option volumes pick up. The real value will be known only when more commodities are brought under the ambit of commodity options.