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.As per current regulatory norms, which style of commodity options may be launched on Indian exchanges, for both Options on Futures and Options on Goods?
- a)Only European style — exercisable only on the expiry date/day
- b)Only American style — exercisable any time on or before expiry
- c)American style for Options on Futures and European style for Options on Goods
- d)Either style, at the exchange's choice for each contract
Show the answer
Answer: (a) Only European style — exercisable only on the expiry date/day
"European option: The owner of such option can exercise his right ONLY ON THE EXPIRY DATE/DAY of the contract. As per current regulatory norms, ONLY EUROPEAN STYLE COMMODITY OPTIONS ARE PERMITTED to be launched in the case of 'Options on Futures' and in the case of Options on Goods traded in the Indian derivatives exchanges."
American style, for contrast: "the options buyer has the option to exercise his right... on or before the expiry of the options contract. The owner of such option can exercise his right AT ANY TIME ON OR BEFORE THE EXPIRY DATE."
Why the other options are wrong:
- (b) American style is defined in the workbook but is not permitted for Indian commodity options.
- (c) Both types are European. Chapter 4 lists "European Options" among the fundamentals that are the same for both Options on Futures and Options on Goods.
- (d) Exchanges have no choice here. The regulatory norm fixes the style.
3.Which goods are eligible as the underlying for "Options on Goods" on a stock exchange?
- a)Any goods listed on eNAM, whether or not futures exist on them
- b)Only goods on which futures contracts are already trading on the stock exchange, or on which the exchange proposes to launch futures on or before the day of launching the option
- c)Only non-agricultural goods that are cash settled
- d)Only goods for which the Government declares a Minimum Support Price
Show the answer
Answer: (b) Only goods on which futures contracts are already trading on the stock exchange, or on which the exchange proposes to launch futures on or before the day of launching the option
"Stock exchanges are permitted to introduce option contracts with underlying as goods. ONLY THOSE GOODS ARE ELIGIBLE AS UNDERLYING FOR THESE OPTIONS, ON WHICH FUTURES CONTRACTS ARE ALREADY TRADING ON THE STOCK EXCHANGE OR EXCHANGE IS PROPOSING TO LAUNCH THE FUTURES CONTRACTS ON OR BEFORE THE DAY OF LAUNCHING OPTION IN THOSE GOODS. This is in addition to the options on commodity futures."
Why the link to futures matters: "These option contracts shall have SAME QUALITY SPECIFICATION, DELIVERY CENTRES, FINAL SETTLEMENT PRICE METHODOLOGY etc. as in the case of corresponding futures contract." Their delivery obligations are also netted with the futures on the common expiry day.
Why the other options are wrong:
- (a) eNAM is a spot platform and is not the eligibility test.
- (c) Options on Goods settle by physical delivery, not cash. "All open positions convert into physical delivery at expiry." The workbook's own examples include maize.
- (d) MSP works like a put option, but it does not decide which goods qualify.
Where this is taught
Free preparation for NISM Series XVIRelated terms
- Black-76 modelThe variant of the Black-Scholes model used to price Options on Futures, which substitutes the futures price F for the spot price and discounts the whole payoff at e^(-rT).
- 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.
- European-style optionAn option that can be exercised only on its expiry day; the only style permitted for commodity options on Indian exchanges, including options on futures, options on goods and index options.
- Explicit instructionThe instruction an option buyer must actively give to exercise a close-to-the-money or at-the-money commodity option — without it, the option simply expires, unlike an in-the-money option, which exercises automatically.
- Options on FuturesA European commodity option whose underlying is a futures contract, so exercise devolves into a futures position opened at the strike price rather than into delivery of the goods.
- 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.
- Contingent liability on written optionsThe entry an option seller must record for a probable commitment to buy or deliver goods on exercise, since a written option is an open-ended obligation, unlike a purchased option, which is simply an asset.
- CTT on exerciseCommodities Transaction Tax charged on the purchaser, not the seller, when an option is exercised — 0.0001% of settlement value into futures or delivery, or 0.125% for any other settlement mode.
- StandardisationThe exchange fixing a futures contract's size, quality, delivery place, delivery date and permitted price moves, so strangers can trade the same contract on a public market.
- Futures carry effectThe reason a call on futures carries more intrinsic value than a call on goods, while a put on goods carries more than a put on futures — because before expiry the futures price sits above the spot price.