In a first of its kind, MCX today on the occasion of Dhanteras will unveil commodity options trading in the precious yellow metal. Here's a take on the several associated advantages and disadvantages.
The foremost advantage of the new instrument is that it shall act as a hedge against fluctuating gold prices.
Options contract also come with a one-time fee that is paid as premium. The options contract in gold being introduced are European styled i.e on the date of expiration of the contract only the option for the contract can be exercised.
Also, in case price of the gold moves sharply, the option buyer has no obligation to exercise his buy or sell the underlying instrument in the contract but only can exercise the option on his discretion. So, the loss value shall be limited to the price paid to buy the gold options contract also referred as premium money.
As with future contracts, margin calls by brokers to maintain a certain sum with them as good faith to keep the contract intact is made on a daily basis. But in the new derivatives instrument in gold there shall be no such margin calls on a daily basis.
Here is an illustration explaining how gold options contract helps in hedging any price risk in the yellow metal:
Say, you begin trading in gold options contract with the underlying instrument for the derivatives contract being futures contract. With it you aim to protect the value of your gold holdings, say which is procured at a cost of Rs. 30000 for 10 gm. Now as you expect price to decline, you can buy a options put contract with a strike price of Rs. 30000 and if the gold price falls to Rs. 29000 per 10 gm, on expiry of the contract you will make a profit of Rs. 1000.
Also, the net profit shall be less as you need to dole out an amount as premium for the options contract.