Currency Futures

Given frequent sharp movements in the US dollar rupee rate, it looks as though currency futures are not going to be just another trading instrument; they are likely to be very useful for many people in a variety of situations.

Because of small lots, every one can participate in this market. Margins levied are even lower than for gold in commodity futures. Currency futures are the most liquid of markets. And the tick size (the minimum price movement in a market) announced is just a quarter of one paisa, which makes entry and exit easier for retail clients.

Importers and exporters use currency futures to hedge foreign currency exposure. Some of the business from the OTC (over–the-counter) market controlled by banks will be transferred to the currency futures markets. Transparency and liquidity will ensure that companies with exposure of less than US$ 5 million find the currency futures markets much friendlier.

For example you bought a kilo of gold on the commodity futures exchange at Rs 11,000 per ten grams. So you paid Rs 11 lakhs, plus an exchange specified margin of about 4%. You are betting gold prices will go up in rupees. But in fact, gold prices depend on international gold prices denominated in US dollars. So you are really betting gold prices will go up in global markets.

If the price does go up from, say $700 per ounce to $707, you’d expect a gain of 1% in rupees, too. But in the meantime, if the rupee appreciates against the dollar from Rs 42 to Rs 41.50 your dollar price gain is effectively wiped out. The rupee price of gold may remain roughly the same. So if you trade a commodity with international pricing, it makes sense to take a position on currency futures markets.

To counterbalance the effect of the currency on the commodities so that you have a pure commodity play, you should sell the US dollar in currency futures markets when you take a buy position in the commodity. In our example, you’d sell the dollar in currency markets at Rs 42, and buy it back at Rs 41.50 with value and timings coinciding with the commodity positions. Whatever loss is booked in the commodity position due to currency movement will accrue as profit from currency futures market. Similarly if you take an initial sell position in the commodity, buy the US dollar in the currency market of equal value. In either case you’d need to unwind the commodity and the currency positions together.

If you receive money from abroad, your monthly rupee income is continuously at risk. Suppose you get $2,000 a month from abroad. At Rs 49, you get Rs 98,000 this month. But if the price falls to Rs 47 your rupee income will drop to Rs 94,000 a loss of Rs 4,000 in a month. You can reduce uncertainty by selling $2,000 every month for the next 12 months right now. Every time you physically encash the dollars ‘de-hedge’ the immediate month position. For instance:

1. Money to be received next month (December 31) = $2,000
2. Sell $2,000 on December 1 at current price say Rs 49 to the dollar.
3. On December 31 say the dollar is at Rs 47. En-cash US dollars from your bank at Rs 47 and buy back your sold dollar position again at Rs 47.
4. So, the physical currency conversion will give you 47 x 2,000 = 94,000, and the futures position will give you (49-47) x 2000 = Rs 4,000.
5. Net proceeds are 94,000 + 4,000 = 98,000.

Currency is an asset class: Currency is an asset class like equities, commodities or art. It’s favored worldwide for its ability to re-price other assets. The currency futures market is your ticket to universal asset allocation. Of course, the above examples assume perfect conditions and zero trading cost. But the fact is that currency futures markets are internationally used to mitigate risk.