For a very long time, the only way Indian businesses could hedge their currency exposure was to approach their banks for buying a forward cover in the OTC forward market. The OTC market was a closed market for forex risk hedging, which was a telephone market between banks, large financial institutions and mutual funds. With the launch of currency derivatives on the NSE and the BSE, it is now much easier to cover your currency risk by just opening a trading account with your broker. These currency futures and currency options can be bought and sold from the comfort of your home through the internet trading platform itself.
The currency derivatives permit you to take a hedge against hard currencies like the US Dollar, Euro, UK Pound and the Japanese Yen. However, since most of India’s trade and commerce continues to be denominated in USD, the INR-USD pair has become the most popular pair in the currency derivatives market. One can participate in the currency derivatives market for trading and speculation purposes as well as for managing your underlying exposure to the currency. But first let us understand the benefits of trading in currency derivatives, especially the USD-INR pair
Also Read: Know the technical differences between OTC market and exchange regulated markets
Benefits of opting for the USD-INR pair in the currency derivatives market
Any resident Indian or NRI can participate in the USD-INR pair, even if there is no underlying, up to a limit. This is unlike the forward market where you can only hedge an underlying currency exposure.
The bid-ask spreads are as low as 0.0025 in the near month pair and that substantially reduces the liquidity risk while trading. Also, the USD-INR is a fairly liquid pair and is possible to get quotes both ways with minimal risk.
Unlike the forward market mechanism, which is a closed market, the USD-INR pair is based on the transparent market mechanism. This makes it a lot more preferable for individual traders with limited access to information and insights. In fact, like your normal equity / F&O trading screen, you can log into your trading terminal and see the 5 best buy and sell quotes with volumes that reduces information asymmetry substantially.
You can access the USD-INR pair either through your broker or directly from your internet trading platform which adds to the convenience and reduces the hassles of trading
Trading in the USD-INR Futures in the currency derivatives market
As traders intending to take positions in the USD-INR pair, you need to understand a basic difference vis-à-vis the equity markets. When you buy the equities, you are actually betting on the price of the equity to go up. On the contrary when you are buying the USD-INR paid, you are actually betting on the US dollar to appreciate or in other words you are expecting the INR to depreciate against the US dollar. If you are actually expecting the INR to appreciate against the dollar then you should be selling the USD-INR futures. Settlement of currency derivatives will happen on the last working day of the month which will also be the date for interbank settlements in Mumbai. Unlike commodities trading, all USD-INR pairs as well as pairs with Pound, Euro and Yen are all necessarily cash settled.
The snapshot above captures the live quotes for the August USD-INR pair and the order book shows the selling and buying depth at different price levels. You will see that subsequent ticks are at a price gap of 0.0025 paisa as mentioned earlier in this article. The current quote of the USD-INR pair is at 63.94. If you expect the USD dollar to appreciate to around the 66/$ level due to a possible rate hike by the Fed, then you will buy the USD-INR futures in the market. On the other hand, if you expect that the INR will strengthen due to heavy FII flows and the rupee will strengthen to 62/$, then you will have to sell USD-INR currency futures.
How to trade USD-INR options in the currency derivatives market
Over the last few years, the currency options market on the USD-INR has become extremely popular and liquid. In fact, under the governorship of Dr. Raghuram Rajan the RBI became an active player in the currency options market, especially in the USD-INR option. Let us understand the options trading on USD-INR in greater detail. You can trade calls and put options on the USD INR pair but they will all be necessarily European in nature. Which means the option can either be squared off during the month or can be exercised only on expiry. Like in case of USD-INR futures, the minimum notional value for trading will be $1000, which is roughly equivalent to Rs.64,000/- in Indian rupees. There will be 3 serial monthly options contracts and will be followed by 1 quarterly contract. Let us look at a snapshot of the USD-INR options trading screenshot below
In the above screenshot, we have considered the trading screen of the USD-INR option with strike price of Rs.64. There will be a total of 12 in-the-money option strikes and 12 out-of-the-money options strikes available to you at any point of time. In case you are expecting the USD-INR pair to move up (the dollar to appreciate) then you can buy a call option on the USD-INR pair. On the contrary, if you are expecting the USD-INR pair to move down (the INR to appreciate) then you can buy a put option on the USD-INR pair.
Currency derivatives are extremely accessible to retail investors. The lot size is just $1000, and the margin is normally as low as 2.5% even if you consider both the SPAN and extreme loss margins. Surely, USD-INR offers an important development in the hedging of currency risk!