NCDEX proposes hybrid options trading

Asks Sebi to permit a hybrid of American- and European-style options, which it calls Indian options

With options trading in commodities about to start, the National Commodity and Derivatives Exchange (NCDEX) has asked the Securities and Exchange Board of India (Sebi) to allow derivatives that have elements of the European and American systems.

However, Sebi will approve European-style options, in which the date of expiry is pre-determined and in sync with the expiry of the relevant futures contract. The regulator has conveyed this to market participants.

The National Commodity and Derivatives Exchange (NCDEX), which does mostly agri commodities trading, has asked Sebi to permit a hybrid of American- and European-style options, which it calls 'Indian options'. In American-style options, the expiry can happen at any time during the tenure of the contract.

However, in India, if farmers are to be accommodated, "options is the perfect risk management tool for them. It is important to have one designed specifically for farmers, which will do away with the limitations of the futures. It could be a hybrid option, which can have weekly settlement cycles during the harvest season, giving the farmer the choice and flexibility to deliver the underlying commodity and settle the option depending on prevailing spot prices. Such options can complement the government's minimum support programme", the NCDEX spokesperson said.

During harvest, a farmer can decide the week in which he will exercise his option. Farmers buy the put option as a hedge against price risk.

Market intervention agencies and procurement agencies like Food Corporation of India, NABARD and state marketing federations could be the buyers. The logic behind allowing state agencies to buy agri commodities from derivative markets through options is to save cost and reduce risk. From the farmers' point of view, however, 20,000 of them have traded on the NCDEX so far but they want more commodities to be permitted on the exchange platform, whether futures or options.

Market players, including exchanges, have given their choice of four commodities for options, giving priority. However, Sebi wants to go slow on the new products because it is yet not clear how they will impact prices in the physical markets, who will write the options and how liquid they will be.

Meanwhile, Thomson Reuters has developed India's first Financial Information Exchange (FIX) protocol-based trading front-end system, NEXTRA, for the NCDEX. NEXTRA is equipped to execute regulatory changes quickly and cost-effectively, which assists in efficient intra-day closure, pre-order checks and order flow monitoring. It is one of the country's fastest trading systems and brings a dynamic experience to users to execute complex trading strategies. It will also be better suited to offer products such as options and indices, besides handling high frequency/algorithmic trading. NEXTRA is equipped with a large processing capacity of 1,000 orders per second (which can go up to 3,000 orders per second).