The Commodity Futures Trading Commission agreed yesterday to launch a three-year experiment in trading commodity options on U.S. commodity exchanges.
Commodity options trading has been banned since last June, when the CFTC cracked down on abuses in options traded on the London exchange that were revealed by the Lloyd Carr scandal.
Yesterday the CFTC told its staff to draw up rules that would allow commodity options trading to resume under strict controls. It is expected to take four to six months to draft rules for trading, and several more months to license options exchanges and dealers.
When Congress extended the life of the CFTC last year, it authorized options trading in non-agricultural commodities, but required congressional approval of any CFTC option plan.
A commodity option is the right to buy or sell a predetermined quantity of a commodity at a future date at a specified price. The key difference between an option and a commodity futures contract is the risk to the investor.
An options buyer pays a price -- called a premium -- for the option, and makes money if the price of the commodity rises by more than the premium. If the price rises less, or declines, the option becomes worthless and the investor loses the premium.
A futures contract buyer puts up a margin deposit that is a percentage of the value of the commodity purchase. If the price of the commodity declines, the futures buyer is liable for the entire decline in value, which can be several times the initial margin investment.
Acting CFTC Chairman Gary Seevers said the experiment with options traded on exchanges is meant to see whether they serve a need not met by futures contracts.
Although most of the pressure to trade commodity options has come from exchanges and potential dealers, Seevers said the mortgage banking industry has expressed interest in mortgage options. There is already trading in standby mortgage commitments, which are similar to mortgage options.
Seevers said the CFTC has not determined what commodities will be included in the options experiment, but they most likely will be metals, probably gold and silver.
Establishing a government-regulated program to trade commodity options on exchanges is meant to drive out of business the dealers in unregulated commodity options.