The Union Budget for 2005-06, due to be unveiled on February 28, is likely to announce the launch of options trading in commodities, but of a different kind.
The National Commodity and Derivatives Exchange (NCDEX) has requested the finance ministry to permit options trading on futures contracts in commodities.
An option gives the buyer the right, but not the obligation, to buy the underlying asset. A futures contract, on the other hand, is obligatory on both the buyer and seller.
A futures contract is a transaction between the buyer and seller to buy or sell an asset at an agreed price at a future date. This is a common feature of options trading in shares, stocks and commodities.
However, NCDEX being a futures exchange cannot offer trading on the exchange in the spot or physical asset.
Hence, it has asked the finance ministry to permit trade on the exchange in options on futures, said Madan Sabnavis, chief economist, NCDEX.
"In this type of trade, the underlying will be the futures contract, on which one can take an option," he said.
An option on futures will give the buyer a right, but not the obligation, to buy a futures contract.
The futures contract, in turn, will imply an obligation to buy or sell a commodity at a pre-agreed price at a later date.
This type of option will make it easier for a player to get out of the trade if the price moves against expectations.
The only cost involved will be the option premium, which will be quite small, he said.
In futures contracts also, a trader can get out of a trade, but the cost could be much larger because the trader has to square off his position, Sabnavis explained.
"Thus, at a small price, traders can protect their downside," he pointed out.
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