Commodity Options Trading in India: How It Differs From Commodity Futures

Key Takeaways

1. Commodity options gives the buyer a right, but not the obligation of purchasing or selling commodities at an agreed upon price.The risk faced by the buyer of a commodity is limited to the price paid for the premium.
2. In the case of commodity futures, the agreement obligates both parties, with gains and losses depending on the price movement of the underlying commodity.
3. There is a difference in margin requirements for both: an option buyer pays a premium, while an option seller and a futures trader require margin in case there is a loss.
4. MCX provides options on eligible commodity futures contracts, including contracts linked to commodities such as gold, silver and crude oil. Settlement depends on the applicable contract terms.
5. The selection between commodity options trading and futures trading would depend upon your level of risk-taking ability, available capital, trading objective and the position being considered in the commodity market.

Commodity futures and commodity options both provide exposure to the commodity market, but their structure, costs and risks are different.

Commodity options trading gives the buyer a right without an obligation, while futures involve obligations for both parties under the contract.

Both these investment tools give an opportunity to gain exposure to gold, silver, crude oil, or any other commodity listed on an exchange market without owning the underlying asset. However, the process, the risks involved, and the margin required are totally different. Through this blog, you can understand what exactly commodity options trading is, how it differs from commodity futures, and what a trader must consider while making the choice.

What Is Commodity Options Trading?

Commodity Options Trading involves buying and selling options contracts based on an underlying commodity futures contract.

In India, such options are available on eligible commodity futures contracts through exchanges such as MCX.

A call option gives the buyer a right that allows the buyer to purchase an underlying futures contract at a predetermined strike price prior to expiry.

A put option gives the right to sell at the predetermined strike price. A put option gives the buyer the right, but not the obligation, to sell it at the specified strike price.The buyer pays a premium in advance to buy this right. 

If the option does not move in the expected direction and is held until expiry, the buyer's maximum loss is generally limited to the premium paid, subject to the applicable contract terms.

An option seller receives the premium but has an obligation under the contract and is subject to applicable margin requirements.

Commodity Options Trading vs Commodity Futures: The Core Difference

Commodity Futures are contracts that involve buying or selling a certain amount of commodities at a certain price, at a particular future date. It should be noted that unlike option, futures involve an obligation where both buyer and seller are committed to perform their obligations under the contract at the time of its expiry.

Here's a simple way to compare the two:

The key difference is that an option buyer’s maximum loss is generally limited to the premium paid, while futures positions are subject to applicable margin requirements and gains or losses based on price movements.

Margin and Capital Requirements

In futures trading, there is a need for both initial margin as well as any extra margin calls depending on the market conditions and exchange or broker requirements.. This will require more capital and will also necessitate constant attention, considering that even an unexpected move in the opposite direction could result in margin calls on the same day.

For an option buyer, the premium is paid to purchase the option. The buyer's maximum loss is generally limited to the premium paid. Option sellers are subject to applicable margin requirements because of their obligations under the contract.

Risk and Reward Profile

In the case of futures trading, any gain or loss is directly proportional to the movement of prices in the commodities market. If a trader is bearish on crude oil futures and takes a short position, the position can gain if prices decrease and lose if prices increase, subject to the contract and position size.

When it comes to options trading on commodities, the risk of the buyer is known right from the start, but his reward potential keeps increasing with the favorable price movement in the underlying. This difference means that an option buyer knows the maximum premium that can be lost when entering the trade, while the outcome depends on the underlying price movement and the option's terms.

Common Doubts About Commodity Options Trading

Is commodity options trading only for experienced traders?

This does not have to be the case. Commodity options trading is not limited to experienced traders, but anyone considering it should understand the strike price, expiry, premium, margin requirements and potential outcomes before trading.

Do options always expire worthless if the view is wrong?

No. An option does not necessarily have to be held until expiry. Its value can change before expiry based on factors such as the underlying futures price, time remaining and market conditions. If an option is held until expiry and expires without value under the applicable contract terms, the buyer can lose the premium paid.

Which commodities are available for options trading in India?

The exchange MCX now provides options on various commodities like gold, silver, crude oil, etc., and the list is revised from time to time by the exchange and SEBI.

Is commodity options trading riskier than equity options?

The risk cannot be determined simply by comparing commodity and equity options. Commodity prices can be affected by factors such as global supply and demand, currency movements, weather and geopolitical events. Traders should consider the specific contract, its volatility and the position they are taking.

How mastertrust Helps With Commodity Options Trading

mastertrust offers a commodity trading account on mastertrust.co.in that facilitates futures and options trading in commodities like Gold Futures, Silver Futures, and Crude Oil Futures, along with research updates on Gold, Silver, and Crude Oil, which will keep you updated with respect to the commodity market.

With regard to fees, mastertrust makes it easy by charging Rs. 20/- per order for Stocks, F&O, and Commodity.

Opening an account incurs no cost, with the first-year demat AMC being complimentary, and the choice to upgrade to a demat AMC lifetime free through the payment of a one-time minimal fee. 

The simple approach will ensure that a trader who is venturing into commodity options trading is not weighed down by hidden costs.

You can open an account for commodity trading with mastertrust and monitor live MCX prices, margins, and option chains from one console.

Final Thoughts

The differences between commodity option trading and commodity futures trading lie not only in their names but also in the manner through which their risks are arranged. 

While commodity futures require a reciprocal contract with margins from both parties, commodity options give buyers a defined risk participation at the cost of the premium paid for the trade not working out.

There is nothing that makes either one better; everything depends on your risk capacity, amount of capital and level of active management. 

Frequently Asked Questions (FAQ)

1. What is the main difference between commodity options trading and commodity futures?

Options give the buyer a right without an obligation, and the buyer's maximum loss is generally limited to the premium paid. Futures involve obligations under the contract, and losses can increase as the market moves against the position.

2. How much capital do I need to start commodity options trading?

For an option buyer, the premium is the main upfront amount paid to purchase the option. A futures position requires the applicable margin. The actual amount depends on the contract, market conditions and applicable broker or exchange requirements.

3. Can I lose more than the premium in commodity options trading?

But not as a purchaser. Losses cannot exceed the amount of premium you paid. But option writers have liabilities akin to futures buyers and may be at risk for greater losses.

4. Which commodities can I trade options on through mastertrust?

Options on the MCX include Gold, Silver, Crude Oil, among other commodities, as per updates on the exchange.

5. Is commodity options trading suitable for beginners?

Whether commodity options trading is appropriate depends on the trader's understanding of options, risk tolerance, capital and trading objective. Before trading, it is important to understand the strike price, expiry, premium, margin requirements and potential outcomes.

6. How do I open an account for commodity options trading with mastertrust?

You can open a demat and trading account with mastertrust online, with documentation completed digitally and commodity segment activation available on request.