Learn How to Trade in Currency Options: Currency Options | Motilal Oswal

Currency Options

Forex trading was not as popular in India in previous times, as it is now. Trading one currency with another to gain profit was practically unheard of. Furthermore, the laws in India did not permit investors to engage in active forex online trading. Now, many investors venture into forex trading with a view to earn well. As the value of currency keeps fluctuating, you may be apprehensive to try out currency trading. However, if you are aware that currency values change due to factors such as political developments, economic conditions and growth, the policies of central banks, and so on, then you can use some qualitative measures to trade in currencies with care. 

Fluctuations in currencies affect export and import, the fortunes of which depend, to a substantial extent, on the value of currencies. In order to guard against these changes in value, investors make use of derivatives like currency futures and options. The movements of exchange rates can turn profits for not only exporters and importers, but also for speculators and retail investors. 

Currency Options Demystified

Forex trading online has made many investors make a foray into the currency markets. Although trading in forex is not close to the same degree of popularity as trading in stocks is, Indians are gradually finding their comfort zone in forex markets. For those who have made profits in forex, they find trading easy, as there is much less to do in terms of processes. For one thing, you do not need to open a demat account to trade in currencies, as your profits are achieved in the currency itself. Coming back to currency options, there are two ways that investors can hedge against fluctuations in currency. These are via options and futures. You should know a bit about both, but since options are focused upon here, futures will be just touched upon briefly. 

An option is a contract that gives an investor the right to purchase a specific currency at a particular rate in the future. There is no obligation on the investor’s part to make the final purchase. If investors find the price favourable at the date of the contract, they may purchase the currency, or decline if the price seems unfavourable. Just a mention of currency futures, in this case, there is no choice. The investor has to exercise the right of purchase of a currency by the stipulated date in the contract. 

An Illustration

If you wish to get ahead with your forex online trading in options in India, but are still a little flummoxed, you can get a better idea from the example below: 

Let us say that a company called Buildtech in India has clients in the USA and earns its revenue in USD. The company has expectations that the INR will get stronger against the USD. This may mean losses for a company that earns its revenue in USD. An INR that is stronger will mean less funds in its kitty. In order to offset this loss, Buildtech decides to buy currency options that give the company the right to sell the INR at a particular amount on a certain date, but not the obligation to do so. Now, in case the price of the INR does rise, it can sell the INR bought through its contract of options. 

Currency Options in India

In India, there are two kinds of currency options in India, and these are based on whether you are using options to purchase or sell currency. A put option gives investors the right to sell a currency at a certain price on a predetermined date. In the illustration above, a put option is explained. This is an option that works well when investors expect the value of a currency, such as the INR, to get stronger relative to any other currency. 

While engaging in forex online trading, it is necessary to know about the other kind of options contract investors use. This is called the call option. It gives the right to the investor to purchase currency at a specific rate at a predetermined date. This kind of contract works well when investors believe that the INR’s value will decline vis-a-vis another currency. 

Forex Trading Online and Investing

Currency futures were only introduced to India in 2008. In 2010, currency options followed. Currently, the segment of derivatives of the NSE, National Stock Exchange, offers services in trading derivatives in currency futures with four pairs of currency, and cross-currency options and futures contracts on three pairs of currencies. You can easily buy currency options with the INR against other currencies such as the pound sterling, euro and the US dollar. 

If you have a good broker, you may easily buy put or call options on the pair of USD-INR. You can also use an online trading portal to do this. The options that are offered are termed “European”, and this means that you are allowed to only exercise them on the date of expiry of the contract. Nonetheless, you are permitted to square off transactions by selling options contracts back on the markets. The premium differences between buying and selling would translate to any net gain or loss. 

Lot Sizes

In forex online trading in India, there are certain limitations placed on the amounts traded in India, for Indian investors. In currency options, the lot sizes are small, only USD 1,000, per lot. While this may seem limited, it makes it easy for retail investors to take an active part in trading currencies with options contracts. One thing that all investors must know is that premiums must be paid to brokers, who then pass these on to exchanges. Premiums are kept low, allowing investors to leverage a substantial extent, even trade in big volumes. 

Start Trading in Currency Options

If you are an investor who wishes to try a new trading asset, then currency options is a good way to start. You may be already trading futures and options with stocks, or directly in equity. With futures and options, you do not need to open a demat account, but besides that fact, you can diversify your portfolio and earn rewards. Talking of portfolio diversification, you can check out any of the upcoming IPO offerings too. 

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