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Simplifying Currency Trading

02 Jan 2023 0 COMMENT

Introduction

Today currency has been the medium of exchange for the purchase of goods and services across the globe, which had evolved over centuries from a barter system to a coin system to paper currency to today’s digital currency. The importance of cross-currency was not felt until the commencement of international trade in goods and services. Countries began to trade across borders as they learned that everything could not be produced in each country, or that the cost of producing some items was lower in some countries than in others. Foreign exchange (FX) has evolved as a result of increased international trade, i.e., the value of one country's currency vs the value of another country's currency.

Ways to trade in currency

Currency trading takes places through Over-the-Counter (OTC) market i.e., banks and on exchange platform. Currencies are exchanged in the form of cash, forward, futures and options, which are explained below.

·         Cash:

If you are having a currency of any country other than country of your residence, you cannot use for purchase of goods and services in your country. Hence, you are required to convert it into your domestic currency, which will be done through banks.

·         Forwards:

As the name suggest, it is exchange of contract on a future date at the price and quantity on the trade date. It is a mutual agreement between two parties to honor the contractual obligation. Currency forwards in India happen through the OTC market i.e., Banks. Currency forwards in India are mainly settled in delivery, means you need to exchange one currency for another currency on the date of expiry.

·         Futures:

Futures are like forward contracts except the fact that the transaction is made through an organized and regulated exchange rather than contracted between two parties.

·         Options:

Another derivative instrument, which gives the right to the buyer of an Option but not an obligation to buy or sell the underlying on or before the stated date and price.

Currency Options Demystified

Options as the name suggest, it is the choice of taking or giving delivery of the underlying upon expiry of the contract. The definition of option is “It is a right but not the obligation to buy or sell underlying asset class (equity, commodity and currency) upon expiry of the contract.

Difference between futures and options

Though both futures and options are derivatives contract and carries similarities such as buyer and seller, set underlying asset as well as set settlement date, there are few distinguishing factors as listed below.

  • Futures traders require to pay margin for both buying and selling the contract while options buyers pay premium while options sellers receive premium.
  • In futures trading, both buyers and sellers carry obligation to honour the contract while option buyers get the right to buy/sell the underlying not the obligation while option sellers under obligation to honour the contract if buyer demands for it.

How to trade currency derivatives

To trade in the exchange-traded currency derivatives i.e., futures and options of USDINR, you are required to open an equity trading account with any registered member of the stock exchanges by submitting following documents.

  1. ID Proof
  2. Address Proof
  3. Bank Statement
  4. Cancelled cheque

Upon opening of equity trading and demat account, you are required to ask for segment addition of currency derivatives by providing your bank account statement.

Trading in Currency Options

Currency options trading is similar to currency futures trading with only difference of paying premium for options instead of margins in case of futures and all the remaining activities remaining same. Indian exchanges are permitting weekly and monthly currency options contracts for the benefit of traders.

Moneyness of an option

The moneyness of an option indicates whether the contract would result in positive cash flow or negative cash flow or zero cash flow for an option buyer at the time of exercising the option. Moneyness of an option is categorized into In The Money (ITM) option, Out of The Money (OTM) option and At The Money (ATM) option.

Option pricing and Greeks

In any market condition, the rule of trade is to buy at lowest price and sell at highest price. Same principle applies in option trading also. However, option trading involves payment of premium, whose pricing is dependent on five parameters such as

  • Spot price of the underlying asset
  • Strike price
  • Volatility of the underlying asset
  • Time to expiration, and
  • Risk free interest rate

Conclusion

Exchange-traded currency derivatives—futures and options—are blessings in disguise for Indian traders where they are getting another and most important asset class to trade. Exchange traded currency futures gives an extra leverage for Indian stock traders to trade beyond 3.30 PM when the stock market closes. These instruments are risk mitigating tools for exporters and importers beyond purview of OTC. Exchange-traded currency options are boon for the retail investors as they make trade easiest way in terms of premium payment, which is much lower compared to futures, availability of weekly and monthly option contracts, cash settled contracts. There are two types of options available namely European and American where the former are exercisable on expiry day while the latter can be exercised any time.

FAQs  

·         How do you trade currency derivatives such as USDINR, EURINR, GBPINR and JPYINR?

Open a trading account by submitting your details such as ID proof, address proof, bank statement and cancelled cheque. Upon receiving your Unique Client Code pay margin for futures and premium for options to take positions in the currency contracts.

·         How much margin is required for USDINR?

The contract size of USDINR futures contract is USD 1000, which is expressed in INR. For ex., if USDINR is quoting Rs. 82.0000 per dollar, the value of one contract is Rs. 82000. Hence, the margin for one lot of USDINR is approx. Rs. 2500 – 3000.

·         What is the future of USDINR?

The value of USDINR is dependant on various factors such as GDP, inflation, interest rate, current account deficit, government debt, political stability etc. Hence, the currencies are subjected to changes based on changes in the above-mentioned factors. However, currency plays a vital role in overall growth of economy as well as financial market, its role is very important at all times.

·         How many lots of USDINR can I buy?

As a trader, you are allowed to start your trading in USDINR futures from 1 lot i.e., USD 1000 upto USD 10 million or 6% of total open interest, whichever is higher.

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): Ms. Mamta Shetty, Contact number: 022-40701022, E-mail address: complianceofficer@icicisecurities.com. Investments in securities markets 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. Such representations are not indicative of future results. The securities quoted are exemplary and are not recommendatory. The contents herein mentioned are solely for informational and educational purpose.