Options on futures - current research, global trends & Indian prospects

Abstract

India has long and illustrious history in commodity trading. Indian history is testimony to the trade importance of our country. However exchange based trading has been a new concept. Why we have not been able to establish a leading commodities exchange, despite having such an illustrious past, is debatable. India is an agricultural country and majority of population is depended upon agriculture as their livelihood. Thus any unfavorable price movement in agricultural commodities culminates in adverse political fallouts. This has deterred the governments in the past to make any radical changes. With liberalization things started falling in place automatically. With growing importance of India as strong economy, it wouldn’t be too late before we will have a vibrant exchange traded commodity derivatives market. This will not only entail increased activity in markets but also introduction of new and innovative products. To this effect we have made an effort to analyse the suitability of future options in Indian Commodity Derivatives Market. In the first phase of analysis, we studied the theoretical aspects of future options. It has more advantages than disadvantages and it would not be long before this instrument is accepted and traded globally. We have also briefly discussed about the valuation of such contracts. The second phase of our analysis was to study the commodity derivative markets in emerging as well as emerged economies across the globe. We studied Korean, Malaysian and Brazilian derivatives market as emerging economies and US derivative markets as emerged economy. Except for Brazil future options trading on commodities has not taken off in any of the emerging economies. US on the other hand have a well established market for future options. In the third and final phase we tried to measure the suitability of future options in Indian markets. The key parameters identified for suitability analysis were legal (regulatory), trading volume and efficiency in the market of the underlying asset that is commodity futures contracts. Sugar and Chana was used as case in example to carry out the analysis. To measure the efficiency of chana and sugar markets we conducted unit root and co-integration tests for the spot prices and nearest maturing futures contracts prices for last one and half year. The outcome of analysis suggests that currently regulatory regime is not favorable for such product, the trading volume is low as compared to developed markets and also the futures market is inefficient. Therefore to sum it all, we can conclude that though the advantages of future options cannot be ignored for long, Indian market is not yet ready for this product. However, some favorable policy changes are anticipated, and it’s likely to provide the much needed impetus to commodity derivatives market.