Understanding Commodity Options Payoffs
Commodity options follow the same fundamental payoff logic as equity options but with important differences in contract specifications, lot sizes, and settlement mechanics. Understanding payoff calculations is essential before trading commodity options, as lot sizes are often large and price movements can result in significant absolute profit/loss amounts.
Commodity options in India are available on metals (Gold, Silver, Copper), energy (Crude Oil), and agricultural products (various contracts on MCX and other exchanges). Each commodity has unique characteristics affecting payoff magnitude and risk exposure.
Basic Payoff Formulas for Buyers
Option buyers (long positions) have limited maximum loss (premium paid) and potentially unlimited profit (calls) or large profit (puts). The payoff at expiry depends on the relationship between settlement price and strike price.
Buyer payoffs (ignoring transaction costs)
| Contract | Payoff at expiry | Maximum profit | Maximum loss | Breakeven |
|---|---|---|---|---|
| Long Call | max(0, S − K) − Premium | Unlimited (as S increases) | Premium paid | Strike + Premium |
| Long Put | max(0, K − S) − Premium | K − Premium (if S goes to 0) | Premium paid | Strike − Premium |
Where S = Settlement price at expiry, K = Strike price, Premium = Amount paid for the option.
Basic Payoff Formulas for Sellers
Option sellers (short positions) collect premium upfront but face obligation to honor the contract if exercised. Their payoff profiles are inverse to buyers.
Seller payoffs
| Contract | Payoff at expiry | Maximum profit | Maximum loss | Breakeven |
|---|---|---|---|---|
| Short Call | Premium − max(0, S − K) | Premium received | Unlimited (as S increases) | Strike + Premium |
| Short Put | Premium − max(0, K − S) | Premium received | K − Premium (if S goes to 0) | Strike − Premium |
Commodity-Specific Considerations
Unlike index options where lot sizes are standardized per point, commodity options have varying lot sizes measured in physical units (kilograms, barrels, etc.). This affects absolute payoff calculations significantly.
- Lot sizes vary by commodity: Gold (100 grams), Silver (30 kg), Crude Oil (100 barrels), Copper (1,000 kg).
- Price quotations: Gold in ₹ per 10 grams, Crude in ₹ per barrel—must multiply by lot size for total value.
- Settlement: Most commodity options are European style, settling in cash based on futures settlement price.
- Margin requirements: Often higher than equity options due to volatility and commodity-specific risks.
- Trading hours: Commodity markets have different trading hours than equity markets.
Worked Example 1: Gold Call Option
Scenario: You buy 1 Gold call option with the following details:
- Underlying: Gold futures (100 grams)
- Strike price: ₹60,000 per 10 grams
- Premium paid: ₹500 per 10 grams
- Lot size: 100 grams = 10 units of 10 grams
- Total premium paid: ₹500 × 10 = ₹5,000
Gold call payoff scenarios at expiry
| Settlement Price (per 10g) | Intrinsic Value | Payoff per unit | Total Payoff (10 units) | Profit/Loss | ROI |
|---|---|---|---|---|---|
| ₹58,000 | ₹0 | -₹500 | -₹5,000 | -₹5,000 | -100% |
| ₹60,000 (ATM) | ₹0 | -₹500 | -₹5,000 | -₹5,000 | -100% |
| ₹60,500 (BE) | ₹500 | ₹0 | ₹0 | -₹5,000 | -100% |
| ₹61,000 | ₹1,000 | ₹500 | ₹5,000 | ₹0 | 0% |
| ₹62,000 | ₹2,000 | ₹1,500 | ₹15,000 | ₹10,000 | 200% |
| ₹64,000 | ₹4,000 | ₹3,500 | ₹35,000 | ₹30,000 | 600% |
Breakeven calculation: Strike + Premium = ₹60,000 + ₹500 = ₹60,500 per 10 grams. Gold must settle above ₹60,500 for profit. Maximum loss is limited to ₹5,000 (premium paid) regardless of how low gold price falls.
Worked Example 2: Crude Oil Put Option
Scenario: You buy 1 Crude Oil put option to hedge or speculate on price decline:
- Underlying: Crude Oil futures (100 barrels)
- Strike price: ₹6,500 per barrel
- Premium paid: ₹300 per barrel
- Lot size: 100 barrels
- Total premium paid: ₹300 × 100 = ₹30,000
Crude oil put payoff scenarios at expiry
| Settlement Price (per barrel) | Intrinsic Value | Payoff per barrel | Total Payoff (100 barrels) | Profit/Loss | ROI |
|---|---|---|---|---|---|
| ₹7,000 | ₹0 | -₹300 | -₹30,000 | -₹30,000 | -100% |
| ₹6,500 (ATM) | ₹0 | -₹300 | -₹30,000 | -₹30,000 | -100% |
| ₹6,200 (BE) | ₹300 | ₹0 | ₹0 | -₹30,000 | -100% |
| ₹6,000 | ₹500 | ₹200 | ₹20,000 | -₹10,000 | -33% |
| ₹5,500 | ₹1,000 | ₹700 | ₹70,000 | ₹40,000 | 133% |
| ₹5,000 | ₹1,500 | ₹1,200 | ₹1,20,000 | ₹90,000 | 300% |
Breakeven calculation: Strike − Premium = ₹6,500 − ₹300 = ₹6,200 per barrel. Crude must settle below ₹6,200 for profit. Maximum loss is ₹30,000 (premium paid) even if crude rallies to ₹10,000 per barrel.
Worked Example 3: Silver Call Spread
Scenario: To reduce premium cost, you implement a bull call spread on Silver:
- Buy Silver call: Strike ₹75,000 per kg, Premium ₹2,000 per kg
- Sell Silver call: Strike ₹78,000 per kg, Premium ₹800 per kg
- Net premium paid: ₹2,000 − ₹800 = ₹1,200 per kg
- Lot size: 30 kg
- Total net premium: ₹1,200 × 30 = ₹36,000
Silver bull call spread payoff scenarios
| Settlement Price (per kg) | Long Call Payoff | Short Call Payoff | Net Payoff per kg | Total P&L (30kg) | ROI |
|---|---|---|---|---|---|
| ₹73,000 | -₹2,000 | +₹800 | -₹1,200 | -₹36,000 | -100% |
| ₹75,000 | -₹2,000 | +₹800 | -₹1,200 | -₹36,000 | -100% |
| ₹76,200 (BE) | -₹800 | +₹800 | ₹0 | -₹36,000 | -100% |
| ₹77,000 | +₹200 | +₹800 | +₹1,000 | -₹6,000 | -17% |
| ₹78,000 | +₹1,000 | ₹0 | +₹1,000 | +₹30,000 − ₹36,000 | -17% |
| ₹80,000 (max) | +₹3,000 | -₹2,000 | +₹1,800 | +₹54,000 − ₹36,000 | +50% |
Maximum profit: (Difference in strikes − Net premium) × Lot size = (₹3,000 − ₹1,200) × 30 = ₹54,000. Maximum loss: Net premium = ₹36,000. Breakeven: Lower strike + Net premium = ₹75,000 + ₹1,200 = ₹76,200 per kg.
Profit/Loss Calculation Formula
General formula for any option position at expiry:
- P&L = (Payoff at expiry − Initial premium) × Lot size × Number of lots
- For multiple legs (spreads): Calculate each leg separately, then sum.
- Include transaction costs: Brokerage, exchange fees, STT/CTT, GST.
- Account for currency effects: If commodity is priced in USD and traded in INR (for international markets).
Key Risk Factors in Commodity Options
- Commodity contracts have specific lot sizes and settlement rules: Always verify contract specifications on exchange website (MCX, NCDEX) before trading.
- Large lot sizes amplify risk: A ₹100 move in gold per 10 grams = ₹1,000 impact on 100-gram lot.
- Price volatility: Commodities can be more volatile than equities, especially energy and agricultural products.
- Expiry and rollover: Commodity options typically expire into futures, which may require physical delivery consideration.
- Global factors: Geopolitical events, weather (agriculture), production cuts (oil), central bank policy (gold) all affect pricing.
- Liquidity varies: Some strikes and expiries have poor liquidity—check bid-ask spreads before trading.
- Margin requirements: Can change rapidly during volatile periods, requiring additional capital.
Using Payoff Calculators
While manual calculation helps understanding, payoff calculators streamline analysis:
- Broker platform tools: Most commodity brokers provide built-in payoff calculators.
- Online calculators: Free tools allow inputting multiple legs and visualizing payoff graphs.
- Excel/spreadsheet models: Build your own for custom scenarios and stress testing.
- Key inputs required: Strike price, premium, lot size, expiry, current price, volatility (for Greeks).
- Visualization: Payoff graphs make it easy to understand maximum profit, maximum loss, and breakeven points.
Comparison: Commodity vs Equity Options
| Aspect | Commodity Options | Equity Options |
|---|---|---|
| Underlying | Physical commodities / futures | Stocks / indices |
| Lot sizes | Fixed physical units (kg, barrels) | Fixed number of shares/index points |
| Settlement | Usually cash against futures | Cash (indices) or physical (stocks) |
| Volatility | Often higher, event-driven | Varies by stock/index |
| Influencing factors | Global demand/supply, geopolitics | Company performance, economic data |
| Trading hours | Extended hours for some commodities | Standard market hours |
| Margin requirements | Often higher | Relatively standardized |
Understanding payoff calculations is fundamental to commodity options trading. Always calculate maximum loss, maximum profit, and breakeven before entering any position. Pay special attention to lot sizes as they directly multiply your per-unit P&L into absolute rupee amounts. Practice with small positions initially, and use calculators to validate your manual calculations. Remember that theoretical payoffs don't include transaction costs, taxes, and the impact of bid-ask spreads—factor these into your expected returns for realistic assessment.