Options on Goods
Also written Option on Goods · Options on spot commodities · Options in Goods
A European option whose exercise devolves directly into delivery of and payment for the physical commodity, rather than into a futures position.
In plain language
India got commodity options in two instalments, and the order tells you why they look the way they do.
In 2017-18 the exchanges launched Options on Futures, because futures already sat on the exchange platform under SEBI's eye. Spot commodity markets did not — they are mandis, outside the exchange and outside SEBI — so an option written directly on physical goods was, at that stage, unimplementable.
By 2020 the plumbing had caught up, and Options on Goods arrived. Exercise one and you do not get a futures position. You get the commodity, at the strike price, against payment.
For a farmer that is the honest product. A put on goods at a chosen strike is a private minimum support price: pay a premium, keep the right to sell at that price, and if the market does better, walk away and sell in the mandi.
How it works
An exchange may list an option on goods only where futures on the same good already trade on that exchange, or will be launched on or before the option's launch day. The option inherits the futures contract's quality specification, delivery centres and FSP methodology, and copies its trading hours, intention marking for exercise and lot size.
Crucially, the two expire on the same day — on NCDEX, the 20th of the month for most contracts. Delivery obligations arising from the expiring options are therefore merged with the futures delivery obligations and netted into a single obligation per client.
On exercise:
| Position | Devolves into |
|---|---|
| Long call | Buy the goods — pay, receive delivery |
| Long put | Sell the goods — deliver, receive payment |
| Short call | Sell the goods — deliver |
| Short put | Buy the goods — pay against delivery received |
Pricing uses the original Black-Scholes model on the spot price, not the Black-76 variant reserved for Options on Futures. Contract symbols end in S for spot — MAIZE20MAY20CE2100S is a European call on maize, strike Rs 2,100, expiring 20 May 2020; an F in that position would mean an option on futures.
Margins differ too. There is no devolvement margin and no pre-expiry margin, but tender/delivery period margin is charged on both buyers and sellers of strikes that are ITM or CTM or expected to become so — from E-4 at MCX, over the last three days (E-2, E-1, E) at NCDEX.
A worked example
A maize call on goods, strike Rs 2,100 per quintal, premium Rs 60 per quintal, lot 10 MT = 100 quintals. A poultry feed miller buys one lot in March to cap his raw material cost.
At expiry the polled Final Settlement Price is Rs 2,250 per quintal.
Premium paid = 60 x 100 = Rs 6,000
Intrinsic value = (2,250 - 2,100) x 100 = Rs 15,000
Net gain = 15,000 - 6,000 = Rs 9,000
But the cash flows are not netted. Exercising creates a buy position in the goods at the strike:
| Leg | Amount |
|---|---|
| Pays the writer for 10 MT at the Rs 2,100 strike | Rs 2,10,000 |
| Receives 10 MT of quality-certified maize, worth at FSP | Rs 2,25,000 |
| GST, added on the seller's tax-paid invoice | as applicable |
| CTT on exercise resulting in actual delivery, 0.0001% of settlement price, paid by the purchaser | about Rs 0.23 |
The miller has to find Rs 2,10,000 in cash and somewhere to put ten tonnes of maize. Had he bought the equivalent call on futures instead, he would have ended the day holding a futures position and a margin call, and no grain at all.
Why NISM asks about it
Chapter 4 (Commodity Options), section 4.6 in full, with the margin treatment in Chapter 7 (Clearing, Settlement and Risk Management), section 7.12.3. Expect the definition question ("option on goods in a nutshell is devolvement of options on direct delivery of goods and payment thereof"), the symbol-suffix question, and the comparison question on why an option on goods may be priced higher than a comparable option on futures.
Common exam traps
- Options on Goods do not devolve into futures. They devolve into delivery and payment. That is the whole distinction.
- They use plain Black-Scholes; Options on Futures use Black-76. Same principle, different symbol in the same place, because
e^(-rT) x F = S. - Intrinsic value differs by product. Since F is normally above S, a call on futures has more intrinsic value than a call on goods, while a put on goods has more than a put on futures. The workbook calls this the futures carry effect.
- An option on goods may cost more than an option on futures in a shallow market — the spot market has no Daily Price Limit to damp volatility, and the writer faces a full delivery or payment obligation. In a deep market arbitrage flattens the difference.
- No devolvement margin, but yes delivery period margin — on buyers as well as sellers. Options on Futures are the other way round.
- The tick size of the option may be finer than the underlying goods futures, because it applies to the premium rather than to the full value of the commodity.
Check yourself
1.A buyer of an "Options on Goods" contract will end up having zero or close to zero cash flow on exercise if the option ends up as:
- a)Deep ITM options
- b)ATM or one of the 7 CTM strike options
- c)ATM or one of the 7 OTM strike options
- d)Deep OTM options
Show the answer
Answer: (b) ATM or one of the 7 CTM strike options
(This is a sample question from the NISM workbook.)
An ATM option "would lead to zero cash flow if it were exercised immediately", and CTM options are those "whose strike prices are very close to the spot price." So exercising either produces zero or nearly zero cash flow, before the premium.
Option (c) is the near-miss and the real trap. The seven CTM strikes are not seven OTM strikes — "there are 7 CTM Options: ONE OF WHICH IS ATM, 3 ARE ITM AND 3 ARE OTM." The band is deliberately built to straddle the spot price, three either side.
Option (a) deep ITM gives a large positive cash flow, which is precisely why ITM options are exercised automatically. Option (d) deep OTM would never be exercised at all — it expires worthless.
Why the CTM band exists at all is worth carrying into the exam: taking spot prices through a scientific polling process based on sample selection is highly manual and prone to sampling errors, so the seven-strike band lets traders having positions in border cases of sampling error make their judgement more diligently rather than being forced into delivery by a slightly mispolled price.
2.An option on goods, in a nutshell, is:
- a)Devolvement of options on futures which leads to delivery of goods
- b)Devolvement of futures on options
- c)Devolvement of futures on goods
- d)Devolvement of options on direct delivery of goods and payment thereof
Show the answer
Answer: (d) Devolvement of options on direct delivery of goods and payment thereof
(This is a sample question from the NISM workbook.)
"Options on Goods are direct options for the actual delivery of commodities. Hence, instead of devolving on Futures like in the case of Options on Futures, Options on Goods devolves into DIRECT DELIVERY OF THE COMMODITY to the call option buyers, or direct delivery of commodity BY the put option buyers, when those options are exercised at the expiry."
Option (a) describes Options on Futures — one step removed, since those devolve into a futures position which may only later lead to delivery. That intermediate step is the whole distinction between the two products.
The four devolvement outcomes for Options on Goods:
Position Devolves into Long call A buy position — payment made, delivery received Long put A sell position — delivery made, payment received Short call A sell position — delivery to be made Short put A buy position — payment against receipt of delivery A quick way to identify the product in practice: the contract symbol ends in "S" for spot (Options on Goods) and "F" for futures (Options on Futures) — as in MAIZE20MAY20CE2100S.
3.Which statement about the commodity option pricing models is correct?
- a)The Binomial model was developed by Fisher Black and Myron Scholes in 1973 and needs no iteration
- b)The Black-Scholes model was published in 1973, is fast and does not rely on iteration, while the Binomial model of 1978 is flexible but lengthy and time-consuming
- c)Black-76 is used for Options on Goods while the original Black-Scholes is used for Options on Futures
- d)Both models require the exchange to publish a fixed volatility input each day
Show the answer
Answer: (b) The Black-Scholes model was published in 1973, is fast and does not rely on iteration, while the Binomial model of 1978 is flexible but lengthy and time-consuming
Binomial Black-Scholes Developed by William Sharpe Fisher Black and Myron Scholes Year ⚠️ 1978 ⚠️ 1973 Character "The most flexible, intuitive and popular approach" but "very lengthy and time-consuming" "Most popular, relatively simple, and fast"; "unlike the Binomial model, it does not rely on calculation by iteration" Note the chronology, because it is counter-intuitive: Black-Scholes came first (1973), and the more intuitive tree-based model followed five years later.
Option (c) reverses the correct application, and this is the more examinable error: the original Black-Scholes prices Options on GOODS (using S, the spot price), while the Black-76 variant prices Options on FUTURES (using F, the futures price).
Option (d) contradicts the chapter's opening point: "Prices are never fixed by exchanges, SEBI, or anybody else. Price discovery is a critical and basic component of markets." Volatility is not published — it is implied by the traded price, and "the actual traded price in a liquid options contract may be considered as a representation of the collective view of the market."
Where this is taught
Free preparation for NISM Series XVIRelated terms
- Close to the moneyThe band of option strikes clustered around the at-the-money strike which, in Options on Goods, lapse unless the buyer gives an explicit instruction to exercise them.
- Contrary instructionAn instruction from the holder of an in-the-money option telling the exchange **not** to exercise it — the only way to stop an ITM contract being exercised automatically at expiry.
- Spot price pollingThe statistical process by which an exchange collects physical-market prices from an empanelled panel of traders and users, strips out outliers, and publishes a single daily spot price.
- Tender period marginAn extra margin charged at client level on all open positions once a contract enters its tender or delivery period — the higher of 20% of contract value, or 3% plus a five-day 99% VaR of spot prices.
- Lot sizeThe minimum quantity that must be traded and, on a delivery contract, actually delivered at expiry — equal to or higher than both the trading unit and the minimum order quantity.