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In a historic decision for the Indian commodity derivative market, in 2017, after a lot of demand from trading members, market regulator SEBI (Securities and Exchange Board of India) approved options trading in commodities (futures). In October 2017, options trading on gold (1 kg lots) futures were allowed, making it the first commodity option to be traded on Indian bourses. But what is a commodity trade option or commodity option? 
Key Takeaways
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Commodity options are derivative contracts giving the buyer the right, but not the obligation, to buy (call) or sell (put) underlying commodity futures at a predetermined strike price.
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Only European-style options are traded in India, primarily on commodity futures, under SEBI’s regulation.
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Call options allow buyers to profit from rising prices, while put options allow profit from falling prices, with risk limited to the premium paid.
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Options trading offers cost-effective exposure, risk management, and hedging opportunities compared to full futures contracts.
What Are Commodity Options?
Commodity trade options contracts are rights to buy (call option) or sell (put option) underlying commodity futures at predetermined prices on the date of contract expiry. It is important to note that, unlike in equity options where options involve rights to sell or buy shares of companies at pre-set prices, it works a bit differently for the commodity trading space.
In India, market regulators mostly exclusively allow options trading in the commodity futures market and not the commodity spot market because in India the spot or cash market in commodities is regulated by state governments while the SEBI only regulates the commodity derivatives market.
How Do Options Work?
In options trading, the risk is limited for the buyer of the option, and profit potential is unlimited. This is because the buyer of an option can choose to exercise his/her right to buy an underlying asset at the strike price on the day the contract expires if the strike price is lower than the current market price, which limits his risk of losing money. If the buyer does exercise his right to buy at the strike price, then the seller must execute the trade at agreed terms.
For the seller or underwriter of an option contract, the profit comes from the premium charged for writing the option, which he pockets in any event, whether or not the buyer exercises his right to buy. The sellers or underwriters ride on the notion that most options contracts expire worthless without being executed by buyers.
Different Types Of Commodities
Commodities form the backbone of global trade and investment, providing essential raw materials and serving as investment instruments in derivative markets. Understanding the types of commodities is important for investors and traders, as each category behaves differently based on supply, demand, and external market factors.
The major types include:
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Metals: Metals commodities include precious metals such as gold, silver, and platinum, as well as industrial metals like copper. Precious metals often serve as a safe haven during economic uncertainty or inflation, while industrial metals are closely tied to manufacturing and infrastructure demand. Their prices are influenced by global supply, industrial usage, and investor sentiment.
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Energy: Energy commodities comprise crude oil, natural gas, gasoline, and heating oil. Prices are highly sensitive to geopolitical developments, global economic growth, and supply-demand imbalances. Energy commodities are essential for industrial production and transportation, making them critical for hedging, investment, and speculative trading.
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Agriculture: Agricultural commodities include staples such as wheat, rice, corn, soybeans, as well as cash crops like cotton, coffee, cocoa, and sugar. Their prices fluctuate due to seasonal variations, weather patterns, government policies, and global population trends. Agricultural commodities play a key role in food security and global trade.
What Is A Call Option On Trading Commodities?
A call option gives the owner a right to buy the underlying commodity futures at a fixed price or the strike price on the date of the expiry of the contract. The buyer of an option is said to go long on an option. If the buyer chooses to exercise his right to buy, then on the date of expiry, the options contract devolves into the futures contract.
A buyer of a call option will only execute his right when there is intrinsic value; that is, the strike price is lower than the prevailing price of the commodity futures contract.
Commodity Option Pricing: How Does A Commodity Call Option Work?
A commodity call option gives the buyer the right, but not the obligation, to purchase the underlying futures at a predetermined strike price on the contract’s expiry date. The buyer pays a premium to the seller (underwriter) for this right.
For example, suppose trader G buys a one-month gold call option on futures trading at ₹1,500 per lot, with a strike price of ₹1,150 and a premium of ₹50. If, on expiry, the futures price rises to ₹1,350, G can exercise the option, buying at ₹1,150 and making a profit of ₹200. The option is said to be In The Money (ITM), and the underwriter must honour the contract.
If the futures price falls below ₹1,150, say to ₹1,000, G can let the option expire worthless, losing only the premium paid. This limits the buyer’s risk while retaining potential for profit.
What is a Commodity Put Option?
A commodity put option gives the owner the right to sell underlying commodity futures at a preset price once the contract expires on a fixed date, which is last Thursday of the month.
One can also sell or underwrite a put option on commodity futures, which could expose him/her to pricing risks because if the buyer chooses to exercise his right to purchase the underlying contract, the underwriter will have to honour his side of the deal. But the underwriters’ reward lies in the premium they receive on such put option commodity trades since the belief is, most options contracts will go worthless on the date of expiry when the strike price is higher than current prices.
Commodity Option Pricing: How Does a Put Option On Commodity Trades Work?
A commodity put option gives the buyer the right, but not the obligation, to sell the underlying futures at a predetermined strike price on the contract’s expiry date. The buyer pays a premium to the seller (underwriter) for this right.
For example, suppose trader H buys a one-month gold put option on futures currently at ₹1,500 per lot, with a strike price of ₹1,700. If, on expiry, the futures price falls to ₹1,650, H can exercise the option, selling at ₹1,700, and realise a gain of ₹50. The option is In The Money (ITM) because the strike price exceeds the current market price.
If the futures price rises above ₹1,700, say to ₹1,750, H can let the option expire worthless. This limits the loss to the premium paid while avoiding unfavourable trades.
What Are The Advantages Of Commodity Trade Options Contracts?
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Since commodity option contract buyers pay a premium for these contracts, they are not required to maintain mark to market margins.
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Buying put options in commodity trades are a great way of taking a short position in the futures while minimizing risk. One can choose not to exercise the right to sell if current prices of the futures contracts are higher than the strike price. The stakes are much higher in the futures segment as they involve compulsory delivery.
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Options work out cheaper than futures contracts in terms of returns and risk mitigation as one has only to pay the premium if the rights to buy or sell the underlying asset at pre-set prices are not exercised.
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Experts term options as a type of price insurance in a somewhat volatile commodity derivatives market where one can take advantage of the price volatility on both the directions to hedge one’s pricing risks.
How to Start Options Trading?
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Open a trading account: Choose a broker that supports derivatives trading and complete KYC formalities.
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Enable F&O trading: Make sure that your account is authorised for Futures & Options trading.
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Research options: Identify the index or stock options you want to trade.
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Start with liquid options: Begin with highly traded options to minimise risk and ease tracking.
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Select strike prices carefully: Prefer At-The-Money (ATM) or Out-Of-The-Money (OTM) options with manageable premiums.
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Monitor & Execute: Track market movements, exercise rights if profitable, or let the option expire to limit losses.
Conclusion
Commodity options provide a structured way to participate in the commodity derivatives market with defined risk and potential reward. Key commodities include metals, energy products, and agricultural goods, each influenced by supply, demand, geopolitical developments, and seasonal or economic factors.
Call and put options enable strategic positions based on market expectations, offering a cost-effective alternative to direct futures contracts. For new traders, starting with liquid options and careful strike selection can reduce risk. Overall, commodity options act as hedging instruments and tools for speculation, providing flexibility and risk management in volatile markets.