Informist, Monday, Oct 23, 2023
By Rajesh Gajra
MUMBAI – India's commodity derivatives market is seeing a surge in turnover in options contracts, driven by increased trading in crude oil contracts from retail traders and proprietary accounts of brokers.
In the September quarter, the combined daily turnover in crude oil and natural gas options on underlying futures averaged 772.93 bln rupees, sharply up compared to the June quarter average of 548.23 bln rupees, data from the Securities and Exchange Board of India's recent bulletin showed.
TREND
The trend seems to continue in October. On Oct 13, the Multi Commodity Exchange of India recorded an all-time high options turnover of 1.91 trln rupees. On the same day, the exchange saw the crude oil options on underlying futures turnover touching an all-time high of 1.61 trln rupees. The options turnover figures represent the notional turnover in options contracts.
As of Friday, the average daily turnover of crude oil options on underlying futures contracts in the current month, along with those of natural gas, have surged 34% to 1.04 trln rupees, as compared to the average in the September quarter. In the combined turnover of the two energy commodities this month, the share of crude oil was 87%.
MCX had launched contracts in crude oil options on underlying futures in May 2018 and in natural gas options on underlying futures in January last year. The exchange commands around 98% market share in commodity derivatives turnover among all exchanges which offer commodities derivatives trading such as National Commodity Derivatives Exchange, BSE Ltd, and National Stock Exchange of India Ltd.
Crude oil contracts have always been the best pick for retailers in the domestic commodity derivatives market due to the small contract lot, according to Ravindra Rao, vice president and head-commodity research, Kotak Securities. "Options trading has got features which the retail traders like, for instance, the leverage you can take is far higher than futures, and you can book profits or stop losses faster," said Nilesh Sharma, executive director and president, SAMCO Securities.
In Apr-Sep, nearly 90% of total options turnover on MCX came from the energy commodities--crude oil and natural gas. The other commodities on which options trading takes place on the exchange are gold, silver, and individual base metals such as aluminium and copper.
The average daily turnover in options on underlying futures of crude oil and natural gas contracts during this period more than doubled to 660.58 bln rupees, from 317.50 bln rupees in the whole of 2022-23 (Apr-Mar).
Ironically, the futures on which the options contracts are based have seen a decline in turnover. In Jul-Sep, the combined average daily futures turnover in crude oil and natural gas of 58.27 bln rupees on the MCX was lower by one-third over that of the whole of 2022-23. The futures turnover in crude oil and natural gas makes up for just 8.1% of the total derivatives turnover in the two commodities, implying a near dominance of options contracts.
With crude oil typically being a highly traded commodity, receiving higher information flow than other commodities, and the last few months witnessing higher directional movement in crude oil prices, investors are taking a very high trading interest in its contracts, said Vishal Gulecha, head of retail equities, ICICI Securities, during a post-earnings conference call with investors earlier this month.
MARGINS MATTER
The major volume drivers in trading in derivatives, whether it is commodities or equities, are speculators who carry out varied trading strategies intra-day, intra-week, or intra-month.
The major reason for the surge in options turnover is margins, according to Sharma from Samco Securities. When the commodity derivatives regulator changed from the Forward Markets Committee to SEBI in 2015, the latter got the exchanges to charge SPAN margins on the derivatives contracts. The SPAN, or standard portfolio analysis of risk, methodology is used by domestic and overseas exchanges to calculate the margins for futures and options positions.
"Because of this change, the margins shot up 3-4 times and MCX volumes started declining," said Sharma. The margins on crude oil futures had gone above 100% in 2020, and it was during that time investors shifted their trading to crude oil options on futures from pure futures, said Rao from Kotak Securities.
The introduction of options on futures contracts in May 2018 made that transition possible. There are near-zero margins for options buyers as they have to pay only the traded premium. For options sellers, the margin levels are far lower than on long or short futures positions.
Crude oil futures turnover was more than that of options till 2021-22 on the MCX. But in that year, the average daily turnover in crude oil options on futures rose to 66.16 bln rupees overtaking that of crude oil futures turnover of 44.81 bln rupees.
"In futures trading only two price trends, up and down, are possible, but in options you also have sideways movement strategies to execute," said Rao. There are other additional options strategies that traders can implement and algorithm developers can design into their products, he said.
GOING FORWARD
On the MCX, the overall options volume has gone up, and the rising trend has continued, according to ICICI Securities' Gulecha. "Crude oil will continue to play a dominant part in this given that crude oil prices have shown more volatility than any other commodity in the market," he said.
Competition is rising in commodity derivatives, with the NSE and BSE launching crude oil options on futures contracts and similar contracts in other commodities. With a dominant share in aggregate turnover, the MCX, which recently transitioned its trading and settlement technology platform to one designed and created by Tata Consultancy Services, may not see an adverse impact from competitive pressure in the near term.
"Given the current situation where a commodity derivatives trader is already happy with the high liquidity on MCX, it will be difficult for NSE and BSE," said Sharma from Samco Securities. For existing commodity products, liquidity is the major factor. "Say, you bought options on a competing exchange and when you want to square up you find there is no liquidity; no one would want to take this risk," said Sharma.
Competition to MCX's dominance in commodity derivative can only make a mark if there is product differentiation, according to Rao from Kotak Securities. When retail traders are already getting what they want from an existing liquid platform for a product, they would not like to take risks of low liquidity in another exchange for the same product. End
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