Commodity Options

18.1 Commodity Options: A Long-Awaited Milestone in Indian Markets

Varun: Isha, I’ve traded equity options before, but I didn’t know MCX offers options on commodities too.

Isha: Yes, it’s a relatively recent development. SEBI approved them in 2017, starting with Gold options. Now we have options on crude, cotton, mentha oil, and more.

Varun: That’s a big shift. Why are they useful?

Isha: Because they offer limited downside. You pay a premium and get directional exposure without margin stress. Perfect for hedging or seasonal plays.

Varun: So a cotton mill could hedge harvest risk with a put option?

Isha: Exactly. And traders can use calls or puts to manage volatility across agri and energy contracts.

The journey into commodity trading in India gained momentum nearly two decades ago, marked by early contracts such as pepper futures around late 2005 or early 2006. Since then, the Indian commodity markets have undergone a remarkable transformation. The Multi Commodity Exchange (MCX) has been instrumental in this evolution—broadening market access, launching diverse contracts, and significantly enhancing liquidity. What was once a niche domain has matured into a dynamic ecosystem catering to hedgers, speculators, and arbitrageurs.

One persistent gap in this landscape was the absence of commodity options. Around 2009, discussions about their potential introduction sparked widespread enthusiasm among market participants. Options were seen as a game-changer, offering greater flexibility in risk management and trade structuring. However, the momentum faded. The initiative stalled, and for years, commodity options remained more of a hopeful whisper than a tradable reality.

Regulatory Breakthrough and Market Roll-out

That changed in June 2017, when SEBI officially approved the launch of options on commodity futures. This was a landmark moment. Exchanges like MCX and NCDEX began building the infrastructure to support options trading, starting with Gold options, which were launched in October 2017.

Since then, the segment has expanded steadily. As of 2025, traders can access options on Gold, Silver, Crude Oil, Copper, Zinc, Natural Gas, Cotton, and Mentha Oil, among others. These contracts are European-style options settled in cash, and they’re based on the underlying futures contracts already listed on MCX.

Why Commodity Options Matter

Commodity options offer a powerful tool for managing risk. Unlike futures, which require margin and expose traders to unlimited losses, options provide asymmetric payoff structures. Buyers of call or put options can participate in price movements while capping their downside to the premium paid.

For example:

• A cotton mill can buy put options to hedge against falling cotton prices during harvest season.
• A gold jeweller can buy call options to lock in prices ahead of Diwali demand.
• A Mentha oil exporter can use options to protect against volatility in USD-INR and commodity prices simultaneously.

What to Expect When Trading Commodity Options

The theory behind options—Greeks, payoff diagrams, volatility, and pricing models—remains the same whether you’re trading equity options or commodity options. What changes is the logistics:

• Underlying asset:Commodity options are based on futures, not spot prices.
• Settlement:Most contracts are cash-settled, but some may offer delivery-based options in future.
• Expiry: Typically aligned with the expiry of the underlying futures contract.
• Premiums: Quoted in rupees per unit (e.g., ₹/kg for Mentha Oil, ₹/bale for Cotton).
• Strike selection: Based on the prevailing futures price, with multiple strikes available.

2025 Snapshot: Active Commodity Options

Here are a few actively traded options contracts on MCX as of October 2025:

These contracts offer weekly and monthly expiries, giving traders flexibility to manage short-term and seasonal risks.

18.2  Black 76: Pricing Commodity Options on Futures

Varun: Isha, how do these commodity options actually settle?

Isha: Most are European-style and cash-settled. But if they’re ITM or CTM on expiry, they devolve into futures positions.

Varun: What’s CTM?

Isha: Close-to-Money—two strikes above and below ATM. These need explicit instructions to be exercised. Otherwise, they expire worthless.

Varun: And ITM options?

Isha: They’re auto-converted into futures unless you opt out. So you need to monitor your positions near expiry.

When trading commodity options, one key distinction you need to understand is this: commodity options in India are written on futures contracts—not on spot prices.

Let’s break this down with a comparison. If you’re trading a call option on Biocon, the underlying asset is the spot price of Biocon stock. Similarly, for Nifty options, the underlying is the live Nifty 50 index value. But when it comes to commodities—say, Crude Oil—the situation is different. India doesn’t have a formal spot market for crude or most other commodities. What we do have is a robust futures market, and that’s what commodity options are built on.

So, if you’re trading Crude Oil options on MCX, here’s the hierarchy:

• The underlying for the option is the Crude Oil futures contract.
• The underlying for the futures contract is the global benchmark price of Crude Oil on NYMEX.

This makes commodity options a derivative on a derivative. While that sounds complex, it doesn’t change much in terms of how you trade. But it does affect how the option premium is calculated.

Black-Scholes vs Black 76: What’s the Difference?

Most equity options like those on stocks or indices—use the Black-Scholes model to calculate premiums and Greeks. This model assumes the underlying asset is a spot price.

However, when the underlying is a futures contract, as in the case of commodity options, the correct pricing model is Black 76. This model is specifically designed for options on futures and adjusts how the risk-free interest rate is treated in the formula.

While both models share similar inputs strike price, volatility, time to expiry, and risk-free rate the Black 76 model replaces the spot price with the futures price and modifies the discounting mechanism.

Practical Tip for Traders

If you’re using online option calculators, be cautious. Most tools default to Black-Scholes and assume spot-based inputs. Plugging in commodity futures data into these calculators will give you inaccurate premium values and misleading Greeks.

Instead, look for calculators or platforms that explicitly support Black 76. Many professional trading terminals and broker platforms now offer built-in support for commodity options pricing using the correct model.

Why This Matters

Understanding the pricing model isn’t just academic it affects how you interpret option premiums, manage risk, and structure strategies. Whether you’re buying a call on Crude Oil or a put on Mentha Oil, knowing that you’re dealing with futures-based options helps you align your expectations with market behaviour

18.3 Commodity Options: Contract Specifications and Settlement Mechanics

Varun: Isha, how do these commodity options actually settle?

Isha: Most are European-style and cash-settled. But if they’re ITM or CTM on expiry, they devolve into futures positions.

Varun: What’s CTM?

Isha: Close-to-Money—two strikes above and below ATM. These need explicit instructions to be exercised. Otherwise, they expire worthless.

Varun: And ITM options?

Isha: They’re auto-converted into futures unless you opt out. So you need to monitor your positions near expiry.

With the successful roll-out of commodity options in India, exchanges like MCX have established a robust framework for trading options on futures contracts. While the initial launch focused on Gold options, the segment has expanded to include Crude Oil, Natural Gas, Silver, Cotton, Mentha Oil, and more. These contracts offer hedgers and traders a flexible tool to manage risk and express directional views with limited downside.

Let’s walk through the key specifications and operational details of commodity options as they stand today.

Core Contract Features

1. Option Types:Both Call and Put options are available.
2. Underlying Asset:These are options on futures, not spot prices. For example, a Crude Oil option is based on the MCX Crude Oil futures contract.
3. Lot Size:Matches the lot size of the underlying futures contract. For instance, Gold options have a lot size of 1 kg, while Natural Gas options are sized at 1,250 mmBtu.
4. Order Types: All standard order types are permitted—Limit, Market, Stop Loss (SL), Stop Loss Market (SLM), Immediate or Cancel (IOC), Good Till Cancelled (GTC).
5. Exercise Style:Most contracts follow the European-style exercise, meaning they can only be exercised on expiry.
6. Margins:

• Option Buyers: Pay the full premium upfront.
• Option Writers:Required to maintain SPAN + Exposure margin.
• Devolvement Margin:Applies when an option is exercised and converted into a futures position.

Expiry and Strike Structure

• Last Trading Day:Typically three business days before the last tender day of the underlying futures contract.
• Strike Range: Exchanges offer a wide selection of strikes—usually 31 strikes per series, comprising:

• 1 At-the-Money (ATM) strike
• 15 strikes above ATM
• 15 strikes below ATM

Understanding Moneyness: ATM, CTM, ITM, and OTM

Commodity options introduce a slightly modified classification system compared to equity options. Here’s how moneyness is defined:

• ATM (At the Money): The strike closest to the Daily Settlement Price (DSP) of the underlying futures on expiry.
• CTM (Close to Money): Includes two strikes above and two strikes below ATM. These are considered borderline ITM and require trader action.

ITM (In the Money):

• Call Options: All strikes below ATM (including CTM).
• Put Options: All strikes above ATM (including CTM).

OTM (Out of the Money):

• Call Options: All strikes above ATM.
• Put Options: All strikes below ATM.

Settlement Process and Instructions

Commodity options are settled via devolvement into futures contracts. Here’s how it works:

CTM Options

If you hold a CTM option (e.g., a Gold ₹59,000 Call when DSP is ₹59,000), you must submit an explicit instruction via your trading terminal to convert it into a futures position. If no instruction is given, the option expires worthless, even if it’s technically ITM.

ITM Options (Non-CTM)

These are automatically devolved into futures positions unless you submit a contrary instruction to opt out. For example, if you hold a Mentha Oil ₹900 Put and the DSP is ₹880, the option is ITM and will convert into a short futures position at ₹900 unless you choose otherwise.

Why Opt Out of Devolvement?

There may be scenarios where exercising an ITM option is not economically viable:

• Tax implications: Exercising may trigger capital gains or speculative income.
• Transaction costs:Brokerage, exchange fees, and delivery charges may outweigh the benefit.
• Portfolio strategy:You may prefer to exit the position and avoid holding a futures contract.

In such cases, submitting a contrary instruction prevents automatic settlement and allows the option to expire without devolvement.

Illustrative Example: Cotton Options

Let’s say the DSP of Cotton (29mm) on expiry is ₹56,000 per bale. Strike intervals are ₹500.

• ATM: ₹56,000
• CTM: ₹55,000, ₹55,500, ₹56,000, ₹56,500, ₹57,000

OTM:

• Calls: ₹56,500 and above
• Puts: ₹55,500 and below

ITM:

• Calls: ₹55,000 and below
• Puts: ₹57,000 and above

If you hold a ₹55,000 Call, it’s ITM and will be automatically converted into a long futures position unless you opt out. If you hold a ₹56,500 Call, it’s CTM and requires explicit instruction to be exercised.

18.4 Devolvement: Transitioning Commodity Options into Futures

Varun: Isha, if my option devolves into a futures position, do I need to fund margin?

Isha: Yes. That’s where devolvement margin comes in. You need 50% margin one day before expiry, and the rest on expiry day.

Varun: What if I don’t want the futures position?

Isha: Then submit a contrary instruction. Especially if the tax impact or transaction costs outweigh the benefit.

Varun: So devolvement isn’t automatic for CTM, and optional for ITM?

Isha: Exactly. It’s all about managing exposure and making informed expiry decisions.

When trading commodity options, it’s important to understand what happens when an In-the-Money (ITM) or Close-to-Money (CTM) option reaches expiry. Unlike equity options, which are typically cash-settled, commodity options on MCX devolve into futures contracts. This means your option position transforms into a futures position at the strike price, provided certain conditions are met.

But here’s the catch: futures contracts require margin, and most option buyers haven’t parked that margin upfront. To address this, exchanges have introduced a mechanism called the Devolvement Margin.

Why Devolvement Margin Is Necessary

When you buy an option, you only pay the premium. There’s no obligation to maintain margin for a futures position unless the option is exercised. However, if your option is likely to expire ITM or CTM and you intend to hold it through expiry, you must be prepared to fund your account with sufficient margin to support the resulting futures position.

This is where Devolvement Margin comes into play. It ensures that traders who wish to carry their ITM/CTM options into futures have the necessary capital in place before expiry.

How Exchanges Handle Devolvement

A few days before expiry, exchanges conduct a sensitivity analysis—a “what-if” scenario—to identify which strikes are likely to be ITM or CTM based on prevailing market prices. Based on this report, they begin assigning Devolvement Margin requirements to those positions.

Here’s how the margin funding works:

• 50% of the required margin must be available one day before expiry.
• The remaining 50% must be funded on the day of expiry.

Example: Gold Options (October 2025)

Let’s say the Gold options contract expires on 28 October 2025, and the corresponding Gold futures contract expires on 5 November 2025.

• If you hold a ₹59,000 Call option and the DSP is ₹59,200, your option is ITM.
• On 27 October, you must ensure half the margin required for a long Gold futures position is available in your account.
• On 28 October, the remaining margin must be funded to complete the devolvement.

Impact of Option Depth on Margin

The deeper your option is ITM, the lower the devolvement margin required. This is because the intrinsic value of the option offsets part of the margin obligation. Conversely, CTM options, which are borderline ITM, attract higher margin requirements, as their intrinsic value is minimal or uncertain.

This structure encourages traders to monitor their positions closely and make informed decisions about whether to exercise or exit before expiry.

Devolvement Mapping: What Your Option Becomes

Here’s a quick reference for how different option positions convert into futures:

So, if you hold a Mentha Oil ₹920 Put and the DSP is ₹910, your position will devolve into a short Mentha Oil futures contract at ₹920, provided you meet the margin requirements.

Opting Out: When You Might Avoid Devolvement

There may be cases where exercising an ITM option isn’t beneficial:

• Taxation: Exercising may trigger capital gains or speculative income.
• Transaction Costs: Brokerage, exchange fees, and delivery charges may outweigh the benefit.
• Strategic Reasons:You may prefer to exit the position and avoid holding a futures contract.

In such cases, you can submit a Contrary Instruction to prevent automatic devolvement. This must be done before expiry via your trading terminal.

18.5 Key Takeaways

• Commodity options were introduced in India in 2017, starting with Gold and expanding to multiple assets.
• These options are written on futures contracts, not spot prices, making them derivatives on derivatives.
• Black 76 is the correct pricing model, replacing spot price with futures price and adjusting discounting.
• Using Black-Scholes for commodity options leads to inaccurate premiums and Greeks.
• Options offer asymmetric payoff, allowing traders to cap losses while participating in price moves.
• Most contracts follow European-style exercise, meaning they can only be exercised on expiry.
• CTM options require explicit instruction to devolve, while ITM options are auto-converted unless opted out.
• Devolvement margin must be funded in two stages, ensuring traders are prepared for futures exposure.
• Strike selection and moneyness classification differ slightly from equity options, with 31 strikes per series.
• Traders must monitor expiry closely, submit instructions if needed, and weigh devolvement against costs and strategy.

18.5 Fun Activity

Fun Activity: “Model Match”

Which pricing model for Crude Oil options?

• Black-Scholes
• Black 76

Answer: Black 76 is correct—used for options on futures.