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Currency Derivatives What Is a Currency Derivative?

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Currency Derivatives What Is a Currency Derivative? Currency Derivatives What is a Currency Derivative? “Currency” is a generally accepted medium of exchange for goods and services and circulated within an economy. Each currency of a country is valued with other currency, the net ratio is called “Foreign Exchange Rate”. ”Derivatives” is a financial product which is based on a derived asset called underlying. Underlying can be Securities, Stock Market Index, Currency, Bullion, Commodity etc. “Currency Derivative” is a contract between buyer & seller agreeing to exchange certain currency at a fixed price in the future date Futures and Options are the major exchange traded Currency derivatives instruments Derivatives are mainly used for Directional Trading, Hedging and Arbitrage 2 Currency Derivatives: A History Globally, Currency derivatives were first introduced on Chicago Mercantile Exchange (CME) in 1972 CME is the largest regulated FX market and offers 41 individual FX futures & 31 options contracts on 19 currencies In India, NSE introduced Currency Derivatives on August 29, 2008 with the launch of USDINR Currency Futures NSE launched trading in other currency pairs like Euro-INR, Pound Sterling-INR and Japanese Yen-INR in March 2010 NSE introduced Interest Rate futures trading in Aug 2009 on same platform while Currency Options was introduced in Oct 2010 BSE launched Currency and Interest Rate Derivatives Trading on November 28, 2013 NSE introduced, Cross Currency Futures and Options on EUR-USD. GBP-USD and USD-JPY on February 27, 2018 The total turnover on NSE in last ten years, increased from 1.6 Trillion in FY2009 to 100 Trillion in FY2020 3 Indian F&O Turnover Market Share (2017-18) Interest Commodity 3.3% Rate 0.3% Currency 5.3% Equity 91.1% Source: SEBI Annual Report 2017-18 . In Indian derivative market, currency derivative share is only 5.3% which reflects the potential and opportunity in Indian Currency market. 4 Currency Derivative Exchanges in India Currently India has three National level Currency Derivative Exchanges; National Stock Exchange (NSE): August 29, 2008 Bombay Stock Exchange (BSE): November 28, 2013 Metropolitan Stock Exchange of India (MSE): October 7, 2008 5 How is currency quoted ? Each currency is quoted / paired / valued with another currency • Quote of USD/INR = 75.00 means for every 1 USD paid, INR 75.00 will be received • Quote of EUR/USD = 1.2745 means for every 1 Euro paid, 1.2745 USD will be received 6 Understanding Currency Appreciation & Depreciation Currency appreciation mean, increase in value of domestic currency against foreign currency. In other words it can buy more units of foreign currency than earlier. On the other side Currency depreciation mean, fall in the value of domestic currency against foreign currency and can buy less units of foreign currency than earlier. Example: If the price of USD/INR falls from 76 to 75, then INR would be said to have appreciated in value as you would now need less INR to buy the same number of USD. On other side, in same case USD would have depreciated as less INR would be remitted with same number of USD. 7 Understanding Currency Appreciation & Depreciation INR USD USDINR Depreciates Appreciates 76 USDINR 75 USD USDINR INR Depreciates 74 Appreciates 9 Who are affected by Currency Prices ? 9 Fundamental Factors effecting Exchange Rate 10 Impact of Economic Events on USDINR Events Likely to General Trend for Impact on Impact on Impact USDINR Demand / Supply of USD USD INR Negative Trade Balance Demand for USD increases Appreciates Depreciates (Imports are greater than exports) Increase in Exports of India Excess inflow of USD into the country Depreciates Appreciates Increase in global prices Demand for USD increases Appreciates Depreciates of commodities due to costlier imports FII inflow / NRI forex Increase in USD inflow Depreciates Appreciates remittance is increasing FII are buying back USD Excessive USD Outflow Appreciates Depreciates RBI is Selling USD to Supply of USD Increases Depreciates Appreciates meet demand for the Dollar RBI is buying USD to absorb Absorption of excess USD liquidity Appreciates Depreciates excess USD due to forex inflows 11 NSE Future Contract Specifications Symbol USDINR EURINR GBPINR JPYINR Unit of Trading 1000 USD 1000 Euro 1000 GBP 100000 Japanese Yen Quotation In INR for 1 USD In INR for 1 Euro In INR for 1 GBP In INR for 100 JPY Tick size 0.25 Paisa or INR 0.0025 (4 decimals) Trading hours Monday to Friday, 9:00 AM to 5:00 PM Contract trading cycle 12 month trading cycle Expiry (Last trading) day Two working days prior to the last business day of the expiry month at 12.30 PM Final settlement day Last working day (excluding Saturdays) of the expiry month (Mumbai Interbank) Settlement Daily settlement: T+1. Final settlement: T+2 (Cash Settled in INR) Price Band +/‐3% for contracts with tenure upto 6 months & +/‐5% for greater than 6 months Daily settlement price Calculated on the basis of the last half an hour weighted average price Final settlement price RBI Reference Rate Quantity Freeze Per Order 10,001 lots or greater Initial margin SPAN Based Margin (2% - 5% in ICICIdirect) Source: www.nseindia.com 12 NSE Option Contract Specifications Symbol USDINR EURINR GBPINR JPYINR Unit of Trading 1000 USD 1000 Euro 1000 GBP 100000 Japanese Yen Quotation In INR for 1 USD In INR for 1 Euro In INR for 1 GBP In INR for 100 JPY Tick size 0.25 Paisa or INR 0.0025 (4 decimals) Trading hours Monday to Friday, 9:00 AM to 5:00 PM 12- In-the-money, 12 Out-of-the-money & 1- Near-the-Money – (25 CE and 25 PE) with Strike Price Strike Price Interval of INR 0.25 3 serial monthly contracts followed by 3 quarterly contracts of cycle (March / June / Sep Contract trading cycle / Dec). For Weekly USDINR Options- 11 serial weekly contracts expiring on Friday, excluding expiry week wherein monthly contracts expires on a Friday Expiry (Last trading) day Two working days prior to the last business day of the expiry month at 12.30 PM Final settlement day Last working day (excluding Saturdays) of the expiry month (Mumbai Interbank) Settlement Daily settlement: T+1. Final settlement: T+2 (Cash Settled in INR) Price Band +/‐3% for contracts with tenure upto 6 months & +/‐5% for greater than 6 months Daily settlement price Calculated on the basis of the last half an hour weighted average price Final settlement price RBI Reference Rate Source:Quantity www.nseindia.com Freeze Per Order 10,001 lots or greater 13 Margin Requirements in Currency Futures Contract Initial Margin % Currency Pair Quantity Lot Size LTP Margin Per Lot Value (On 29th May 2020) USDINR 1 Lot 1000 75.7900 75790 4.00% 3032 EURINR 1 Lot 1000 84.3700 84370 4.50% 3797 GBPINR 1 Lot 1000 93.4700 93470 5.00% 4674 100000 JPYINR 1 Lot (100 Yen= 70.6775 70678 5.00% 3534 70.6775) . In Currency Future, in normal scenario required initial margin (IM) is in the range of 2.5% to 5% 14 Equity Derivatives vs Currency Derivatives CMP ICICIdirect Position Future Contract Contract Margin on Fund No. on Derivatives (29th May IM Value in Underlying Lot Value Contract Available Contracts 2020) (29th May 2020) Lakhs Equity NIFTY 75 9580 718500 19.80% 142263 300000 2.1 15.1 Derivative ICIBAN 1375 539.2 741400 33.93% 251557.02 300000 1.2 8.9 USDINR 1000 Currency 75.79 75790 4.00% 3031.6 300000 99.0 75 Derivatives 100000 JPYINR (100 Yen= 70.6775) 70.6775 70677.5 5.00% 3533.875 300000 84.9 60 . As compared to Equity Derivatives margin requirement is around one fifth in Currency derivatives. 15 Equity Derivatives vs Currency Derivatives Equity Derivatives Currency Derivatives • Underlying is Equity Scripts like ITC • Underlying is Currency Pair like USDINR • Hundreds of Scrips • Limited number of Currency Pair • Contract value between 5 lakh to 10 lakh • Smaller contract value (Like USDINR ~76000/-) • Higher Initial Margin (15% - 50%) • Lower Initial Margin (2% - 5%) • Market Timings till 3.30 PM • Market Timings till 5.00 PM • High Volatility • Limited Volatility • High risky as volatility is higher • Low risky as volatility is lower • Contracts available up to three months only • Contracts available up to twelve months • Multiple factors impacting scrips • Connected to Domestic & International Market • Higher taxes: STT and Higher Stamp Duty (0.002% / 0.003%) • No STT / CTT and Very low Stamp Duty (0.0001%) on Buy Side 16 Example: Payoff using Currency Future Trading On 1st May 2020, ABC with the view of appreciation in USDINR initiates Buy position in 100,000 USDINR May 2020 Future. USDINR at 76. Expiry Date: 27th May 2019 Trade Execution: Case I Case II • USDINR Buy Price: 76.00 per $ Assume USDINR on Expiry- Assume USDINR on Expiry- • No of Lots (100,000/1000): 100 78.00 (RBI Ref Rate) 74.50 (RBI Ref Rate) • Contract Value for $100,000 = Profit: Loss: Rs. 76,00,000 (76.00*100000) = (78.00-76.00)*100,000 = (76.0-74.50)*100,000 = INR 200,000 = INR -150,000 USDINR on Expiry Buy value at @ 76.00 Sell value on Expiry Profit/Loss on Expiry 74.50 76,00,000 74,50,000 -1,50,000 75.00 76,00,000 75,00,000 -1,00,000 75.50 76,00,000 75,50,000 -50,000 76.00 76,00,000 76,00,000 0 76.50 76,00,000 76,50,000 50,000 77.00 76,00,000 77,00,000 1,00,000 77.50 76,00,000 77,50,000 1,50,000 78.00 76,00,000 78,00,000 2,00,000 17 Brokerage and Other Costs involved Brokerage: Rs.
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