MCX (Multi-commodity exchange of India) – A snapshot

The Multi Commodity Exchange of India Limited (MCX), is a commodity derivatives exchange that facilitates online trading, and clearing and settlement of commodity futures transactions. The Exchange, which started operations in November 2003. It is listed on the BSE. Currently with a market capitalization of ~Rs 5448 crores.

Most active products are

  • Crude oil
  • Zinc
  • Silver
  • Copper
  • Natural Gas
  • Lead
  • Crude Palm Oil
  • Cotton

Key commodities futures product are as below. Options on these are expected to be introduced soon.mcx products

 

Advertisements

Options on Commodities Futures

Sebi has allowed Derivative Exchanges to allow Options on Commodity Futures as per a circular on their website (13 June 2017).  See link  Sebi circular

In India there are four exchanges were commodity derivatives are traded.

Most contracts are futures (or forwards but since on exchange are futures 🙂 ).

Sebi now allows Options on the futures contracts. This allows for hedging. Also speculation.

Basic criteria is that the futures should have been in the top 5 in trading value over the past 12 months. Basically only liquid futures contracts are eligible.

There is also average daily turnover criteria for the futures over the past 12 months (agricultural Rs 200 crore, other 1000 crore)

Key features

European style exercise

Settlement will be to take the underlying long or short position.

Example

Long call will result in a long position in the future; Long put will result in short position in the future

Short call will result in a short position in the future; Short put will result in the a long position in the future

Position limits for options are separate from futures limits. Margining will be separate.

Due to exercise, the position limits of futures maybe breached. Two working days are allowed to bring these under the limit threshold levels

More on this.

Introduction to Financial Derivatives

A derivative is a financial instrument whose value is derived from another underlying asset. The underlying asset could be

  • Stock
  • Interest rate or foreign exchange rate
  • Index value such as a stock index value
  • Commodity price or index

Value of a derivative is ‘derived’ from another variable

The four basic derivatives types are

  • Forwards
  • Futures
  • Options
  • Swaps

A. Forwards

A forward contract gives the owner the right and obligation to buy a specified asset on a specified date at a specified price. On the specified date, the underlying asset will be received or delivered at this price.

  • The seller of the forward contract has the right and obligation to sell the asset on the date for the price
  • At the end of the forward contract, at “delivery,” ownership of the good is transferred and payment is made from the purchaser to the seller
  • Generally, no money changes hands on the origination date of the forward contract
  • However, collateral may be demanded

Delivery options may exist concerning the

  • quality of the asset
  • quantity of the asset
  • delivery date
  • delivery location

If your position has value, you face the risk that your counterparty will default.

B. Futures

This is a financial contract

  • obligating the buyer
  • to purchase an asset (or the seller to sell an asset),
  • such as a physical commodity (crude oil, wheat, corn) or a financial instrument (debt instruments, stock index, currencies)
  • at a predetermined future date
  • at a predetermined future price

Futures contracts are standardised and are be traded on exchanges. Default risk is lower as they are cleared on exchanges.

Futures and Forwards are identical in structure. The key difference is

  • Futures are exchange traded and hence have no counterparty risk, Forwards are OTC (Over the Counter) products
  • Futures are standardized contracts (done by the Exchange), Forwards are customized by the parties.

C. Options

These are derivatives with the following features

The buyer of an option

  • Has the right
  • but not the obligation
  • to buy (or sell) a particular product
  • on a particular date (Exercise Date)
  • at a particular price (Strike or Exercise Price)

The seller of the option

  • Receives a premium for selling the right
  • Has the obligation to deliver the product when the buyer exercises the option
  • An option seller is also called a ‘WRITER’

Listed Options are standardised and are traded on exchanges

OTC Options are customized and not traded on exchanges

Call Options

  • A call option is a contract that gives the owner of the call option the right, but not the obligation, to buy an underlying asset, at a fixed price, on (or sometimes before) a pre-specified day, which is known as the expiration day
  • The seller of a call option, the call writer, is obligated to deliver, or sell, the underlying asset at a fixed price, on (or sometimes before) expiration day
  • The fixed price is called the strike price, or the exercise price.

 

Put Options

  • A put option is a contract that gives the owner of the put option the right, but not the obligation, to sell an underlying asset, at a fixed price, on (or sometimes before) a pre-specified day, which is known as the expiration day
  • The seller of a put option, the put writer, is obligated to take delivery, or buy, the underlying asset at a fixed price, on (or sometimes before) expiration day.
  • The fixed price is called the strike price, or the exercise price.

Options that can only be exercised at expiration are called “European” options.

Options that can be exercised any time until expiration are called “American” options

D. Swaps

  • A swap is an agreement between counter-parties to exchange cash flows at specified future times according to pre-specified conditions
  • Involves the exchange of cash flows arising from specific
  • Assets
  • Liabilities
  • To exchange one set of cash flows for another without involving the transfer of the asset or liability itself
  • A swap is like a portfolio of forwards. Each forward in a swap has a different delivery date, and the same forward price