Basics of Currency Options & Cross Currency Derivatives Trading

Currency trading is the when you trade in national and international currencies. Trading in foreign currencies is also called FOREX trading. In India, you can do currency trading through a registered broker. The trading happens on two exchanges, MCX-SX i.e. Multi Commodity Exchange and National Stock Exchange or NSE. Investors aim to earn from the variation in the exchange rate of the currencies.

A Forex market consists of Banks, investors, forex brokers, investment firms etc. If you want to do currency trading, then you can do it through currency derivatives. Currency derivatives are a Futures and Options Contract.

Currency Futures

A Currency Future Contracts is where you can exchange one currency for another at a fixed price, at a specified date in the future. Here the buyer has the obligation to buy or sell.

Currency Options

Currency Options, on the other hand, is a contract where the buyer has the right but not the obligation to buy or sell a certain currency at a specific exchange rate on a specific date in the future.

Cross Currency Derivative Trading

In India, if you wanted to do currency trading earlier then it was only possible to trade in one combination of currency futures or currency options. The USD-INR combination. But on 9th March 2016, SEBI passed a circular where it allowed currency options and cross currency derivatives contracts. In India, you can now trade in currency options in the following currency pairs:

  • EUR-INR
  • GBP-INR
  • JPY-INR

When it comes to cross currency derivative trading, SEBI has allowed trading in cross currency derivatives that were not the case earlier. Cross Currency trading can now be done on the following pairs:

  • EUR-USD
  • GBP-USD
  • USD-JPY

These pairs will help the MNCs in India to hedge trading effectively in the Indian Stock Exchange. The stock changes are allowed to do cross currency trading from 9:00 Hrs. to 19:30 Hrs.

The stock exchanges have to implement a dynamic price band so the markets remain orderly and regulated.

The dynamic price band for currency futures and options is as follows:

Dynamic Price Band for Currency Futures

Stock exchanges will have to set a daily dynamic price band of currency futures contracts as mentioned below:

Contracts with Tenure up to 6 months 3% of the theoretical price or the previous day closing price, as applicable
Contracts with tenure greater than 6 months 5% of the theoretical price or the previous day closing price, as applicable

The dynamic price bands shall be relaxed in increments of 1% as and when a market-wide trend is observed.

Dynamic Price Band for Currency Options

  1. For currency options, stock exchanges shall implement a dynamic price band mechanism based on the theoretical price of contracts.
  2. The dynamic price bands shall be relaxed as and when a market-wide trend is observed in situations of high volatility.

Stock exchanges shall frame suitable rules with mutual consultation for such relaxation of dynamic price bands and shall make it known to the market.

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