Introduction to currency futures; how you can hedge currency risks

For students studying abroad, travellers going for foreign vacations and expatriates earning in rupee terms, a weaker rupee has a big impact on their plans

Kavya Balaji Nov 19, 2019

Currency tradingDo you know that the Indian rupee was at Rs 48 per US dollar in February 2012? This means that the Indian rupee has depreciated by close to 50 per cent in seven years and most of this depreciation happened in 2013 and 2018. This might have been interesting for some but for some others it might have been a nightmare. This includes importers, exporters and other businesses who deal in foreign currency.

Due to currency movements, expected revenues or expenses or costs would vary adversely and affect the overall viability/profitability of the organisation that has to deal with foreign currencies. Not only businesses, individuals could also get affected by currency fluctuations. For students studying abroad, travellers going for foreign vacations and expatriates earning in rupee terms, a weaker rupee has a big impact on their plans.

Want to insulate yourself from such currency fluctuations? Then, it is important to hedge your foreign currency exposure. This is where currency futures come in. Read on to find out what you need to do.

What are currency futures?

Just like stock futures, currency futures are contracts to buy or sell foreign currency at a predetermined date and price. Based on your views of the currency movements, you could insulate yourself and your business from currency risks.

How do currency futures work?

Suppose you are importing articles from the United States for Rs 7,00,000 when the dollar is Rs 70 with a 90 days credit. You are required to pay $10,000 after three months. Let us assume the rupee depreciates to Rs. 75 a dollar at the end of three months. You would have to shell out Rs 50,000 more. This is where currency futures help. You could buy 10, three months futures contracts at the rate of Rs 70 per dollar. If the exchange rate rises to Rs 75 after 3 months (when payment is due), you would make a profit of Rs 5 per dollar or Rs 50,000 (5 x 1000 x 10).

Who can trade in currency derivatives?

Any resident Indian can trade in currency derivatives. Unfortunately, the market is not open to non residents. In 2017, the Securities Exchange Board of India (SEBI) permitted Non-Resident Indians (NRIs) to participate in the currency futures market in India. This will help NRIs to hedge the currency risk that affects their investments in the country.

Which are the exchanges for currency derivatives trading?

Currently three stock exchanges offer currency derivatives – National Stock Exchange (NSE), Multi Commodity Exchange (MCX) and the Bombay Stock Exchange (BSE). NSE has the largest share in the currency futures market.

How to start trading in currency futures?

Just like equities, you need a demat account for trading in currency derivatives. To start trading, participants need to open a trading account with a member broker of a currency exchange by fulfilling the Know Your Customer (KYC) formalities. However, this is only for individuals. An institutional trader or corporate needs to obtain prior permission from Reserve Bank of India (RBI) to trade in currency derivatives.

Since currency movements are not easy to grasp, it is best to approach a brokerage with a good research team to trade in currency derivatives. Alternatively, you could open an online trading account. While choosing a broker, ensure that he is indeed registered with the exchange on which you want to trade. After the account opening procedure is completed and appropriate margin has been provided to the brokers, one can start trading in currency futures.

What are the currencies available and what is the margin?

You can trade in US dollars, Euros, British pounds and Japanese Yen.
Margin is the amount of money that you need to deposit with your broker for making a trade. This is to protect you from potential losses. For example, if you buy one lot of USD-INR futures contract expiring in December for Rs 100 and the margin is 3 per cent, you would need to deposit Rs 3000 (1 * 1000 * 100 * 3%).

Stock exchanges set margin limits based on Standardised Portfolio Analysis of Risk (SPAN) and currently this is anywhere between 2 and 4 per cent. Margins are subject to change at the discretion of the exchange.

Trading Unit USD 1000 EURO 1000 POUND STERLING 1000 YEN 1000
Initial Margin SPAN based SPAN based SPAN based SPAN based

Is there a trading limit?

The Reserve Bank of India (RBI) increased the trading limit for currency futures in 2018. The position limit across all foreign currency-rupee pairs is $100 million per user in all exchanges combined. Traders can take positions in exchange-traded currency derivatives without any underlying. The limit for this is up to $15 million per exchange for the dollar-rupee pair. For other currency pairs, including euro, yen and sterling, with the rupee, the limit is $5 million per exchange. This means that the total limit is $60 million collectively across three exchanges – NSE, BSE and MCX.

How to place orders?

You will need to decide on the following before placing an order – currency pair (eg. USD-INR), contract validity (eg. two months) and number of lots (eg. if you are looking at $10,000 USD, you need to buy 10 lots).

What are brokerage charges?

Charges on currency futures trading are pretty low and range between 0.03 and 0.05 per cent.

What to do?

Based on currency movements, you can buy or sell futures.

Expectation Action
Rupee to depreciate Buy futures
Rupee to appreciate Sell futures

As we all know currency fluctuations have been high and are now stable but nothing is certain. Even though the US dollar has settled in a range, participants should not take this for granted as any small movement out of this range could mean losses for you. Note that the trade talks between US and China and supply cuts by the Organization of the Petroleum Exporting Countries’ (OPEC) members could have an impact on the Indian rupee. So, it is best to hedge your currency exposure.

All told, currency futures are high risk products. Currency options might be better suited for those with lower risk appetites.

Kavya Balaji

Kavya Balaji is a senior contributing writer with RupeeIQ. With more than 14 years of experience in the finance space, Kavya loves everything to do with personal finance. She feels financial literacy is important for every household and likes to stick to simple language for explaining personal finance stories. She is a consultant with investment management companies. In spare time, she reads murder mysteries.

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