Multi Commodity Exchange (MCX) plans to offer Index Options in Commodities

Multi Commodity Exchange of India (MCX) has come up with a new offering: Index Options in commodities. While the approval to launch the Index Options from the regulator is awaited, investors were overjoyed to hear the news; it was reflected in the share price of the stock. MCX’s share price jumped over 20% in the last five trading days.

Pandemic-induced market conditions and global market factors largely led to Bull Run in commodities, particularly in the last one year. Majority of the traders played along the rally by buying stocks of companies that cater to the commodity sector. But very few traders opted for taking a position in MCX stock itself.

In contrast to the equities where volumes are high, volumes are quite low in the commodity markets and are incomparable. There are quite a few reasons for low volumes. These are partly related to headwinds from the global oil markets; In April 2020, prices in the oil contracts closed below zero causing big losses to traders and brokers. Gold has been in the subdued mode for the past one year.

But, despite the fact that the global headwinds have favoured commodities (particularly oil and metals), MCX’s share price did not budge a great deal; SEBI restrictions were one major factor.

Changes implemented by SEBI in the trading margin system in the Indian capital markets was a major reason for lower volumes. In the last one year, higher margin requirements have sharply impacted volumes in MCX.

Yet there is light to be seen at the end of the tunnel. Reports circulating in the media say that MCX, following a great response from the traders in commodity Index futures, has applied for approval (Options trading in commodity indices) from SEBI. The regulator has hinted that it shall discuss it in its board meeting in the very near future.

Off late, MCX launched individual Options for commodities which received tremendous response from traders. Maturing trader community is largely the reason for MCX to make a case for the new offering.

In order to capitalise on the market scenarios, Options buying allows traders to have the flexibility of using various Options strategies and requires lower capital infusion. Regardless of the underlying asset, Options in indices have always been very popular overseas. Chicago Board Options Exchange (CBOE) is the largest commodity exchange on the planet; Index Options average daily volume is 2.2 million whereas for futures the average daily volume is 0.2 million. The fact is that trader participation is higher in Options in comparison with cash or futures. Institutional investors who deploy trading strategies to hedge their portfolio account for around 50% of the total commodity derivatives volume internationally.

MCX has selected a leading technology partner (TATA Consultancy Services) to build the new technology core which will transform its trading experience and MCX’s end-to-end operations. Traders can expect increased arbitrage volumes, ultra-low latency and many other features which will be particularly useful for algorithm-based traders.

As on date, exchange traded funds are allowed in gold. Besides, MCX is vying for regulatory reforms which will allow new opportunities such as ETFs in other commodities. MCX recently launched a metal Index–Metldex which is witnessing an increasing participation from the traders. A commodity trader shall have the Option of trading in all hard commodities (such as metals) by betting on the Index.

In NSE, Index Options constitute over 90% of the total exchange volumes. For MCX, Index Options in commodities have the potential of becoming the main product. This will not only help in generating volumes but also increase market depth. That is one reason why the stock price of MCX has rallied to new highs when the news on Index Options became public.