Tinesh Bhasin explains the pros and cons of trading in gold 'options', which were introduced in India this Dhanteras.
For the first time in the country, those investing in gold will be able to use options contract for gold.
The Multi Commodity Exchange (MCX) launched gold option contracts on Dhanteras, October 17, with 1 kg gold futures as the underlying asset.
"Those who already deal in gold futures on commodity exchanges have been looking forward to this development. Options work out to be cheaper than futures for trading," says Ajay Kedia, director, Kedia Commodities.
He points out that the premium required for options would be much lower than the margins needed for futures. Even the brokerage fees is lower.
"This will make a lot of retail investors participate in gold options," Kedia says.
But experts warn that one needs to be well-versed with futures and options in equities before looking at gold derivatives.
"If you don't have a deep understanding of futures and options and their strategies, avoid derivatives completely. While there's possibility of high profits the opposite is also true if an individual doesn't understand derivatives. But for seasoned investors this is the place to be," says Jayant Manglik, president–retail distribution, Religare Securities.
In options, by paying a small premium, a trader can take a large exposure to gold.
If prices do not move as anticipated, he can let the option go unexercised, and will lose only the premium.
Say, a trader wants to buy gold from a seller after a month but wants to lock in the price today.
After negotiation, the trader enters into an option agreement with the seller. It gives him the right to buy the 1 kg of gold for Rs 30 lakh after a month.
To execute this option, the trader pays the seller, say Rs 60,000.
After a month, two situations may arise.
One, the gold price goes up. As the ruling prices are higher, the investor may prefer to exercise his option of buying the commodity at the agreed price of Rs 30 lakh.
Anything above Rs 30 lakh is his profit.
But the prices can also move down.
In such a scenario, the buyer can let the option expire. All he loses is the premium of Rs 60,000. This is the simplest option trade.
It can get complicated depending on where you anticipate the prices to move and the strategy you use. If you are a seller (call/put writer) of options, you can also lose high sums of money in such a trade.
That's why for retail investors it's best to look at simpler products rather than speculating on the future price of gold.
Sovereign gold bond is one option for them. The paper gold also earns interest every year. But these are long-tenured bonds.
They list on exchanges but liquidating them at an appropriate price can be challenging as there's little demand in the secondary market.
If you are planning to buy gold in the short term, you can buy digital gold in small quantities regularly from sellers such as Paytm or Motilal Oswal Securities.
Both the companies have tied up with MMTC-PAMP India. Individuals can buy small quantities of gold, store it free of cost, and ask for delivery at a later date in the form of coin or bar.
The gold can even be sold back to MMTC-PAMP India online instantly.
Photograph: Ian Waldie/Reuters.