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Low margin, High Leverage - in Currency Derivatives

The global currency market is the second-largest financial market after interest rates because of its wide usage for the exchange of goods and services, making international payments by importers and exporters as well as governments. Further, the size of the currency market decides the growth of any particular country. Off late, the currency derivatives are gaining more importance amongst the financial market participants for trading as well as hedging the price risks. In India, Currency Futures were introduced  in 2008 followed by currency Options in 2010. 

Currency derivatives—Futures and Options—are one of the most sought financial instruments amongst the investors in the Indian financial market because of their suitability to each and every investor, i.e. from retail investors to corporates. Currency futures are low margin and high leverage derivative contracts as compared to  derivative contracts in other segments.. More importantly, these are  preferred  instruments for exporters and importers to manage the forex volatility  effectively due to multiple factors like standardized contracts, price transparency, low margin, low impact cost, etc.  .Further, currency derivative contracts could be traded at an exchange for five days a week from  9.00 AM to 5.00 PM. . Some trade statistics gives us a glimpse of the volume and market depth of trading in currency derivatives. Let’s see it as below:

FY: 2020-21

Number of Contracts Traded: 2,286 (Both F&O)

Number of Futures Contracts: 1016

Number of Options Contracts: 1270 (25% higher than Futures Contracts)

Margin Requirement

Margin requirement in currency futures is low compared to equity futures. Let’s understand it by the help of example as given below: -.  

Table 1:

Segment

Contract

Margin Requirement (Approx.) *

CMP

(Approx.)

Margin Amount Required Per Lot

Total Amount Available For Trading

Number of Lots that Could be Purchased/ Traded

Equity

Nifty 50

12%

17,500

105,000

200,000

1

Currency

USDINR

3%

74.75

2,242.50

200,000

89

Source: NSE and MCX.

Pl note, margin requirement may vary as per an exchange requirement.

We can see that since margin requirement in currency futures is lesser than Nifty 50 futures, a higher number of lots could be traded with a limited amount of money. This makes trading in currency futures lucrative and provides an easy mode of entry to those who want to trade with limited amount. To trading in currency derivative, open demat account with ICICI Direct

With lower margin, comes the benefit of higher leverage also. As we have seen in the above example that in currency futures, margin requirement for USDINR is just 3%. It provides an opportunity to take position in multiple lots within a given amount of money as compared to in Nifty 50. Advantage of leverage is that a price movement on a favourable side, would yield higher profit. Continuing with our example in Table 1, let’s see an advantage of leverage, as below in Table 2: -.

Assumed, a price movement of 1% in each Nifty 50 and USDINR.

Table 2:

Segment

Contract

CMP (Approx.)

Price Movement %

Price Movement Per Lot

 

(CMP*Price Movement %* Lot Size )

Total Price Movement

(Price Movement Per Lot * Number of Lots)

Equity

Nifty 50

17,500

1%

8,750

8,750

Currency

USDINR

74.75

1%

747.5

66,528

 

Pl remember, leverage is a double edge sword. While it could augment profit, it could magnify losses in an event of unfavourable price movement.  

From the above table, we can see that the currency futures could be   lucrative  for retail investors as they require  minimal margin compared to other futures contracts such as equity  futures... Another feature that could be of interest is that currency derivatives are cash-settled contracts. This absolves traders from compulsory delivery of stocks, should it be allotted to them by an exchange.. 

Also Read: What are Currency Derivatives & Its Meaning?

Summary

A person who is willing  to enter into financial derivatives market, currency futures and options are the one of the best instruments, as the margin is low and one  can take position in available currency pairs with ease and low risk. . Currency derivatives are available in both weekly and monthly contracts and could be traded at an exchange for five days in a week from 9:00 AM to 5 PM.

Get an understanding who is willing  to enter into financial derivatives market, currency futures and options are the one of the best instruments, as the margin is low and one can take position in available currency.

Disclaimer: ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. Name of the Compliance officer (broking): Mr. Anoop Goyal, Contact number: 022-40701000, E-mail address: complianceofficer@icicisecurities.com. Investment in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.