Currency Derivatives
What is Derivative?
A financial contract between two people or two parties that has a value determined by the price of something else (called the underlying). e.g. NIFTY Index Futures-It derives its value from the S&P NIFTY 50 index.
What is Currency Derivatives?
The term 'Derivatives' indicates it derives its value from some underlying i.e. it has no independent value. Underlying can be securities, stock market index, commodities, bullion, currency or anything else. From Currency Derivatives market point of view, underlying would be the Currency Exchange rate. Derivatives are unique product, which helps in hedging the portfolio against the future risk. At the same time, derivatives are used constructively for arbitrage and speculation too.
What is an "Underlying" and how is it different than "Contract"?
A Currency exchange rate enabled for trading on futures is called an "Underlying" e.g. USDINR. There may be various tradable contracts for the same underlying based on its different expiration period. For example FUT-USDINR-27-Aug-2009, FUT-USDINR-28-Sep-2009 and FUT-USDINR-28-Oct-2009 are "contracts" available for trading in currency futures having USDINR Exchange rate as "underlying".
How is the Currency Futures contract defined?
USDINR future contract expiring on 27 Aug, 2009 is defined as "FUT-USDINR-27-Aug- 2009". Wherein, "Fut" stands for Futures as currency derivatives product, "USDINR" for underlying currency exchange rate and "27-Aug-2009" for the expiry date.
When do the Currency Futures contracts expire?
commodity futures contracts expire two working days prior to the last business day (i.e. Last trading day at exchange) of the expiry month.
What are the benefits of trading in Currency Derivatives?
Currency Derivatives are very efficient risk management instruments and you can derive the below benefits:
- Hedging: You can protect your foreign exchange exposure in business and hedge potential losses by taking appropriate positions in the same. For e.g. If you are an importer, and have USD payments to make at a future date, you can hedge your foreign exchange exposure by buying USDINR and fixing your pay out rate today. You would hedge if you were of the view that USDINR was going to depreciate. Similarly it would give hedging opportunities to Exporters to hedge their future receivables, Borrowers to hedge foreign currency (FCY) loans for interest and principal payments, Resident Indians, who can hedge their offshore investments.
- Speculation: You can speculate on the short term movement of the markets by using Currency Futures. For e.g. If you expect oil prices to rise and impact India's import bill, you would buy USDINR in expectation that the INR would depreciate. Alternatively if you believed that strong exports from the IT sector, combined with strong FII flows will translate to INR appreciation you would sell USDINR.
- Arbitrage: You can make profits by taking advantage of the exchange rates of the currency in different markets and different exchanges.
- Leverage: You can trade in the currency derivatives by just paying a % value called the margin amount instead of the full traded value.
Who is eligible to trade in Currency Derivatives?
All Resident Indians as defined in section 2(v) of the Foreign Exchange Management Act, 1999 (FEMA, Act 42 of 1999) are eligible to trade in the Currency Derivatives segment. For participation by regulated entities, concurrence from respective regulators should be obtained. Currently, trading facility in Currency Derivatives at I-Sec will be offered to all Resident Individuals / HUFs / eligible Corporates fulfilling the FEMA criteria.
What are the currencies in which we can trade in Currency Futures?
Currently, in Future USDINR, EURINR, GBPINR, JPYINR and in Option USDINR is permitted by the exchange.
How is Currency Futures trading different from Equity Derivatives trading?
Equities Derivatives trading allows you to trade in Stocks and Index. While Currency future trading allow you to trade in currencies; currently in USDINR, EURINR, GBPINR, JPYINR in Future and USDINR in Option. Settlement in both the segments is presently done in cash.
Do I have to pay the full contract value on placing orders in Currency futures?
No. You will be required to place a certain % of order value as margin, while placing a buy/sell position in Currency Futures. With Currency Futures trading, you can leverage on your trading limit by taking buy/sell positions much more than what you could have taken in the Spot market. However, the risk profile of your transactions goes up.
How is the Initial Margin (IM) calculated on open position?
For example, you have open buy position in FUT-USDINR-28-Dec-2009 for 1 lot of 1000 qty @ Rs.50 and IM % for USDINR is 5%. In that case, margin at position level would be 1 * 1000 * 50 * 5% = Rs.2500/-.
What is meant by calendar spread?
Calendar spread means risk off-setting positions in contracts expiring on different dates in the same underlying.
E.g., you take Buy position for 1 lot of FUT-USDINR-28-Sep-2010 @ Rs.50 and sell position for 1 lot of FUT-USDINR-28-Oct-2010 @ Rs.51. 1 lot of buy position in FUT- USDINR-27-Sep-2010 and 1 lot of sell position in FUT-USDINR-28-Oct-2010 form a spread against each other and hence are called "Spread Position". This spread position would be levied spread margin % for margin calculation instead of Initial Margin.
Contracts will be removed from the spread benefit 1 working day prior to the expiry of the near month contract. Therefore, client will have to provide full margin required on all position taken for positions forming a spread.
Can the orders be removed or modified?
Yes, client can modify or delete the orders, until it is not executed, from the trading work station either by him or by placing the order with designated dealers.
Can I put take profit and stop loss orders simultaneously with the trade orders?
Client can place orders for taking profits or for restricting the losses by putting "stop loss orders", once the trade order has been executed, otherwise it there can be a case where “stop loss” or “take profit” orders are executed before the trade orders.
How is the profit or loss recognized for my orders? When are the margins released?
Once the trade executed has been squared off, the profit/loss is credited/ debited in the client’s trading limits.
Margins blocked on a trade position are released only after the Currency Future positions are squared off.
Net amount, after considering the following, is released:
- Margin blocked on Positions
- + Add margin released
- +/- Profit/Loss incurred on square off
- - Applicable taxes.
What is meant by End of Day-Mark To Market (EOD MTM) margin?
Daily EOD MTM is a regulatory aspect of Currency futures Settlement Process. Every day the settlement of open Currency Futures position takes place at the Settlement Price declared by the exchanges for that day.
The Base price of the Open Positions is compared with the Settlement price and difference is cash settled the next day. In case of profit/loss in EOD MTM, Limits are increased/reduced by the amount of profit/loss net of applicable brokerage, taxes, and statutory charges. The position is carried forward to the Next day at the previous trading day's Settlement price at which last EOD MTM was run.
Settlement price for all the contracts are provided by exchange after making necessary adjustment for abnormal price fluctuations. It is the weighted average price of the last half an hour trading on the exchange.
Is it compulsory to square off the position before expiry date of contract?
No. You need not square off your position till the contract expires. In case there is no instruction from client’s side, then position would be closed at the final settlement price as per the current regulations. The Final Settlement price shall be the Reserve Bank Reference Rate on the last trading day of such currency derivative contract, or as may be specified by the relevant authority from time to time. Margin blocked on such expired position will also be released and added into your trading limits after adjusting profit/loss, applicable brokerage, taxes and statutory levies on close out.