There is good news for investors. The Reserve Bank of India (RBI) and Securities and Exchange Board of India (SEBI) have allowed recognised stock exchanges to launch European-style options in dollar-rupee, based on the spot rates.
In August 2008, the market regulator allowed stock exchanges to introduce currency futures, a forex derivative contract to buy or sell one currency against another, on a specified future date, at a price decided in the contract. Initially, the currency futures were limited to rupee-dollar only.
In January 2010, it was extended to three more currencies - euro, British pound sterling and the Japanese yen - pairing with the rupee. The RBI and SEBI jointly regulate these products.
Options
The currency option is a derivative instrument that gives the owner the right, but not the obligation, to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. With the launch of options, volumes are expected to rise. The advantage of options over futures is that the former limits the downside to the extent of the premium paid for the exposure while the upside is unlimited. An option gives the buyer the right, but not the obligation, to exercise the contract.
Futures
In a futures contract, a trader's position is marked to the market at the end of a trading day. This would provide another alternative to corporates to hedge against currency fluctuations. Trading in this has been allowed only for residents
The National Stock Exchange (NSE) and MCX Stock Exchange will be able to offer options in the dollar-rupee pair after seeking SEBI's approval. The United Stock Exchange (USE) is a new stock bourse expected to go live in September. The Bombay Stock Exchange (BSE) is the largest shareholder in USE which has over 20 public and private banks as its stakeholders.
The NSE was the first exchange to launch futures trading in dollar-rupee in August 2008. This was followed by MCX-SX. The two exchanges now offer futures trading in four currency pairs - dollar, euro, yen and pound with the rupee.
According to the guidelines, the underlying will be dollar-rupee spot rate with a minimum size of 1,000 dollars. The options will be premium styled European call and put options, and will have to be quoted and settled in rupees. The price of the settlement, however, will be RBI's reference rate on the date of expiry.
Contracts
The exchanges will be able to offer three serial monthly contracts followed by three quarterly contracts of the cycle - March, June, September and December. The minimum lot size of the option contract will be 1,000 dollars, the same as that of a futures contract, making it easy for small investors to take positions. The maximum lot size has been fixed at 10 million dollars or six percent of the total open interest, whichever is higher.
Trading members and banks enjoy higher position limits of 50 million dollars and 100 million dollars respectively, or 15 percent of market wide open interest, whichever is higher. The premium will be quoted in rupee terms but the outstanding positions will be in dollar terms. The margin, which the writer of the option pays to the exchange, will be worked out on the worst case loss scenario in a day. While an investor will be able to exercise the option only on expiry of the contract, fixed at two working days prior to the last working day of the expiry month, it will be possible to square off the contract during the life of the contract. The contract will be settled at the RBI's reference rate.
Eligibility
Those eligible to trade are traders registered with SEBI for currency futures, stock exchanges and clearing corporations with RBI authorisation under FEMA, and banks who have RBI approval (banks of minimum net worth of Rs 500 crores)
A minimum of three in-the-money, three out-of the-money and one nearthe-money strikes will be provided for all available contracts. The contract has to be settled in cash in rupees.
The options contract will be settled on the last working day (excluding Saturdays) of the contract month. The last working day will be taken to be the same as that for interbank settlements in Mumbai. The rules of interbank settlements, including those for 'known holidays' and 'subsequently declared holidays', will be as laid down by the Foreign Exchange Dealers' Association of India (FEDAI).
On the expiry date, all open long in the money contracts, on a particular strike of a series, at the close of trading hours will be automatically exercised at the final settlement price, and assigned on a random basis to the open short positions of the same strike and series. The initial margin requirement will be based on a worst scenario loss of a portfolio of an individual investor comprising his positions in options and futures contracts on the same underlying across different maturities and across various scenarios of price and volatility changes.
