Currency Derivatives are contracts through which investor agrees to buy or sell certain units of a particular currency at the expiry of the contracted period. It is similar to the Stock Futures but in this case; the underlying is a currency cross (i.e. USD INR, EUR INR, JPY INR OR GBP INR) instead of Stocks.
Introduction of Currency Futures in India
The introduction of trading in currency Futures effective August 29, 2008, on National Stock Exchange (NSE), was a major milestone in the Indian financial market evolution. Subsequently, Reserve Bank of India (RBI) and Securities and Exchange Board of India (SEBI) permitted trading in USD INR currency futures in other stock exchanges, albeit with some control. Currency futures in India are cash settled and not physically settled that means that they are settled without the actual delivery of the currency on expiry.
Currency futures allows investors to buy or sell a currency at a future date at a previously fixed price. Trading of this instrument at stock exchanges has facilitated an additional avenue and greater flexibility to investors and corporates in India to hedge their foreign currency exposure. It also ensures more transparency in dealing.
Currency Derivatives trading at Stock Exchanges being at a nascent stage, the lot size has been pegged at 1000 units of the overseas currencies in case of USD, EUR & GBP and 100,000 in the case of JPY, with a maximum tenor of 12 months. Further, it is mandatory to settle these contracts in local currency i.e. in Indian Rupee. FII and NRI can not participate directly in this trading. However, once the market reaches a level of maturity and can withstand the pressures of volatility, one can expect withdrawal of these restrictions.
COMMONLY USED TERMS IN CURRENCY TRADING
The exchange rate means the units of one currency expressed in the units of other currency which are offered or accepted in exchange for one another.
Various terminologies in foreign exchange deals:
Spot price: The value of one currency offered or accepted the for delivery or settlement. In the case of USD INR, spot value is T + 2.
Futures price: The price at which the futures contract trades in the futures market.
Contract cycle: The currency futures contracts on the SEBI recognized exchanges have monthly expiry with a maximum of 12 month period. Hence, these exchanges can have 12 contracts outstanding at any given point in time.
Final settlement date: Value Date or Final settlement Date of each contract means the last business day of the contract cycle.
Expiry date: It is the last working day on which the final trade has to take place in the specified contract cycle period. Since for USD INR trades, trade needs 2 days for settlement, the expiry date for such contracts is two working days before the final settlement date or value date.
Contract size: In the case of USD INR it is USD 1000; EUR INR it is EUR 1000; GBP INR it is GBP 1000, and in the case of JPY INR it is JPY 100,000. (Ref. RBI Circular: RBI/2009-10/290, dated 19th January, 2010).
Spread: Spread means the difference between futures price and the spot price. In a normal market, the spread is positive.
Initial margin: The derivative trades are transacted through a broker at the exchange; Investor has to deposit a certain amount with the broker before initiation of the trades. The amount that so deposited is known as initial margin. The margin requirement for currency trading is quite low which makes these trades highly leveraged market, and a small move could wipe your whole deposit.
You can check out the Span Margin Requirements for Currency Futures and options on the SAMCO Span Margin Calculator.
Mark-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor’s gain or loss depending on the closing price of the futures which is known as marking-to-market. Depending on the profit and loss, the investors have to replenish the account to maintain the initial margin.
Intraday currency segment leverage (MIS) ranges from 3X to 15X depending on the underlying pair Intraday derivatives segment (MIS) trades are allowed at almost half the normal margins. Intraday cover order (CO) / Bracket order trades which have built in compulsory stop loss order can have far higher leverage than the normal. These are all compelling proposition to employ successful currency trading strategies for magnified returns.
Brokerage while Trading Currency Futures
Unlike Traditional brokers, at SAMCO, currency traders are charged flat Rs. 20 per executed order or 0.02%, whichever is lower.
You can check out the Currency Brokerage Calculator Here.
Why is currency futures trading in USD INR/ GBP INR/ EUR INR/ JPY INR emerging as a popular tool for traders, scalpers, jobbers?
There are 2 primary reasons why currency futures is emerging as a popular instrument for trading
- Lower Transaction Costs – Unlike the Equities or Commodities Derivative trading where STT and CTT are applicable respectively, no STT is applicable while trading in currency derivatives meaning lower transaction costs and therefore higher profitability for traders
- Small Tick Size and High Liquidity – The tick size in trading currency options is 1/4th of a paise i.e. 0.0025 and the contracts are extremely liquid as well.