Understanding the application of Currency Derivatives

Hey, You must have witnessed how USD is volatile for a couple of months. Looking at rising Geopolitical risk globally, USD being a global currency has started strengthening. But let me tell you , when Such global currency pairs are volatile, they impact Exporters & importers locally. 

India is a net import country, Majority of our import payment is done with USDINR. In this situation when USD starts strengthening , our importers have to spend a higher amount of Indian rupees to buy USD. 

In order to avoid such a situation, there are some tools which can protect them. In the financial world they are called derivatives. 

Under the umbrella of Derivatives, currency derivatives services are used to hedge Imports & exports. Hedging is basically protecting your payments & receivables from any kind of currency fluctuations. 

In India, currency derivatives are traded on Indian Exchanges. 

Currency Derivatives are traded in two ways. One through banks where banks are a counterparty and called forwards. Another one is traded on Exchanges & are called Futures. 

Let us deep dive into Exchange traded Currency Futures.  

1. Currency Pairs : There are four currency pairs , traded on NSE & BSE. Such currency pairs are USDINR, EURINR, GBPINR & JPYINR. One more cross currency pair is traded where INR is not one of the currencies is EURUSD. Out of all the currency pairs, USDINR is the most active currency pair. 

2. Lot size: Currency pairs are traded in the lot size of 1000. Only for JPYINR the lot size is 1 Lac JPY.  So if USDINR rate is say 80 then Lot value will come to 80*1000 Lot size = 80000 Rs

3. Margin: Since Currency Derivative is a leveraged product, the buyer & the seller of the contract has to pay margins. Here. Margins are around 2.5% to 4% depending upon the volatility of the currency pair.

4. Expiry: The currency derivatives contract expires on the second last business day of the month.  So if the last business day of the month is 30th & it`s the business day, currency contracts will expire on 28th of the same month.  

Settlement : Here, settlement takes place in two ways. One is daily settlement where your position is marked to market . Means at the day end whatever the profit or the loss is there on the position, you have to either pay or receive. Second settlement takes place at the expiry of contract. It is called a final settlement. 

Comparison with Index Derivatives

Ideally Currency Derivatives are very less volatile compared to NIfty & Bank Nifty Index. Even margins are also less if we compare with Index or stock derivatives. When for index derivatives, the margin of one lot comes to 1.10 Lac , the same for currency derivatives comes to Rs 2K to 2.5K . 

Conclusion

If you are an aspiring trader, then Currency Derivative is a good product to start with. Just because it comes with less volatility & less margins. If you are an exporter or an importer then, you must hedge your exposure with Currency Derivatives consultants. 

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