Business Today

After Future comes currency options

SEBI is readying the framework for more currency derivative products, beginning with options. What are they and how do they differ from currency futures?

twitter-logo Anand Adhikari        Print Edition: June 27, 2010

What are currency options: They are tradable instruments that provide an option or the right to buy or sell currency during a specified period of time at a specified price. They are just like stock options with the only difference being the underlying asset—a foreign currency asset, a US dollar, euro or yen.

How it works: Options allow a derivatives trader to take a bet on the future direction of a currency. A trader can buy (a call option) if he thinks the currency will appreciate, and sell (put option) if he foresees a grim future for a particular currency.

How they differ from currency futures: The biggest difference is the risk. With currency futures, a trader is exposed to unlimited losses or profits as the buyer or seller is under obligation to honour the contract. The risk in buying a currency option is, however, far less as the losses or profits are limited to the option premium which he pays at the time of entering into a contract. This is because the trader has an option and a right (with no obligation) to use the contract to his advantage on expiry.

Who benefits from it: Currency options offers investors, traders and corporates a hedging tool. They also give speculators another platform to make money on currency movements. There are large engineering firms, for instance, which have foreign exchange receipts and also outstanding payments in multiple currencies that require proper hedging.

Dangers associated with it: Unlike stocks, the factors affecting a currency are altogether different. They range from a political ideology to government policies (like China) to economic and monetary issues.

When will they be introduced in India: Market regulator Securities and Exchange Board of India (SEBI) will shortly issue the framework for options trading on the Indian stock exchanges. The currency futures have been traded since August 2008, starting from rupee-dollar to a handful other currencies now.

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