Federal commodity regulators voted yesterday to revive trading in non-agricultural commodity options that were outlawed 35 years ago because of widespread abuses.
The Commodity Futures Trading Commission approved new regulations for a pilot program in options trading that is expected to begin sometime next year.
The options rules now must be submitted to Congress, which retained the right to veto resumption of options trading when it gave the CFTC authority over options in 1974.
The pilot program will allow each of the nation's commodity markets to offer options on one commodity. The exchanges will choose the commodity, but no options will be permitted on U.S.-grown agricultural products, which are still covered by the options ban enacted by Congress in 1936.
Options could be traded on commodities such as gold, silver, cocoa, mortgages or government Treasury notes.
The CFTC vote set the stage for a potential confrontation with the Securities and Exchange Commission, which regulates options on stocks and some other types of investments. The two agencies disagree about which has jurisdiction over some kinds of options trading.
Proponents of commodity options contend they offer investors a means of speculating on changes in commodity prices with less risk than commodity futures contracts.
A commodity option gives an investor the right to buy or sell a specified amount of some commodity on a future date at a predetermined price.
A futures contract not only gives the investor the right to buy or sell some commodity, but also the obligation to do so. An investor who buys a soybean futures contract will have to pay for a carload of beans unless the contract is sold before its expiration date.
The options investor does not have the obligation to buy or sell the commodity, only the option to do so if the price is attractive. Thus, the risk of being stuck with an unwanted commodity is avoided.
The cost of investing in commodity options is expected to be higher than investing in futures, but the amount the investor risks will be less.
An investor pays a predetermined price called a premium for the option to buy a commodity such as gold. If the price of gold rises, the investor exercises his option, gets the gold and resells it at a profit. If the price of gold falls below the option price, the option becomes worthless, and the investor loses the entire premium.
A futures investor puts up what amounts to a down payment called a margin deposit to buy a gold futures contract. If the price of gold goes up, the investor profits. If the price drops sharply -- as gold did last year -- the futures investor can lose not only the down payment but the full amount that the price falls.
The limited risk of options is supposed to make them more attractive to investors.
During prolonged debate on the options regulations yesterday, CFTC member James Stone made several attempts to amend the staff-written rules to include provisions he said would protect small investors from abuses in options sales and trading. Each of Stone's amendments died for lack of a second, and the regulations were approved on a 3-to-0 vote with Stone voting "present."
The options regulations adopted yesterday by the CFTC now go to Congress, which has 30 working days to review them. If Congress takes no action, the rules can be implemented.
The CFTC then will designate markets for options trading. At first, each U.S. commodity futures exchange will be permitted to start an options program for one of its commodities. CFTC Chairman Phillip Johnson has indicated he wants all the exchanges to start trading options at the same time so none of them gains a competitive advantage from an early start.
Under the CFTC rules, the options cannot be exercised to buy the commodity directly. Instead the option will give the investor the right to buy a futures contract, which then can be used to buy the actual commodity. The CFTC said it wants to study further eliminating the futures contract and allowing options for direct purchase of physical commodities.