The Securities and Exchange Board of India vide Notification dated 16th January 2020 has permitted option in goods in commodity derivatives segment. It has also notified the product design and risk management framework for the option.
SEBI in its earlier circular dated 18th October 2019 has declared that a instrument evidencing a contract for the purchase or sale of a right to buy or sell a good in future, may be called as ‘Option in Goods’. Further Exchanges which are willing to start trading in options contracts with underlying goods shall take prior approval of SEBI for launching such contracts.
Product Design and Risk Management Framework for Option in Goods
Under the eligibility criteria, only those goods on which the exchange is either trading futures contracts or is proposing to launch futures contracts would be permitted.
In case of proposed futures contracts, the same should be launched on or before the day of starting option in the goods concerned. Exchanges can decide on the expiry day of options contracts.
Each option expiry shall have minimum three strikes available viz., one each for In the Money (ITM), Out of the Money (OTM) and At the Money (ATM).
On expiry, the following mechanism shall be adopted by exchanges
- Option series having strike price closest to the price of the underlying shall be termed as At the Money (ATM) option series. This ATM option series and three option series having strike prices immediately above this ATM strike and three option series having strike prices immediately below this ATM strike shall be referred as ‘Close to the money’ (CTM) option series.
- All option contracts belonging to ‘CTM’ option series shall be exercised only on ‘explicit instruction’ for exercise by the long position holders of such contracts.
- All In the money (ITM) option contracts, except those belonging to ‘CTM’ option series, shall be exercised automatically, unless ‘contrary instruction’ has been given by long position holders of such contracts for not doing so.
- All Out of the money (OTM) option contracts, except those belonging to ‘CTM’ option series, shall expire worthless.
- All exercised contracts within an option series shall be assigned to short positions in that series in a fair and non-preferential manner.
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