Trading stock and futures options are comparable to trading currency derivatives. Despite that, the fundamental assets consist of currency pairings like EURINR or USDINR rather than stocks.
Dealing occurs in the foreign exchange market for currency options and futures. A foreign currency's value in relation to the home currency is the foreign exchange rate. In India, banks, businesses, exporters, and importers are the primary participants in currency trading. In this article, learn about currency derivatives' meaning, their popularity in India, benefits and more.
Popularity of Currency Derivatives In India
Despite introducing currency options in 2010 and currency futures in 2008, importers-exporters and central banks remain dominant in the Indian currency derivatives market. The primary contributors to the daily volume of 44,859 Crores are corporations, banks, importers, and exporters.
However, there has also been a rise in the involvement of arbitrageurs and speculators in the currency markets. Currency derivatives in India will become increasingly popular as more ordinary investors learn about the potential for profit in the foreign exchange market.
Advantages of Trading Currency Derivatives
Now that you know what are currency derivatives, let's explore their benefits. Trading currency derivatives allows you to speculate, take advantage of arbitrage opportunities in the world's largest financial market, and hedge against swings in exchange rates.
? Hedging
By trading currency futures to take a hedging position, you, as an investor, can shield your capital from exposure to foreign exchange risk and fluctuations.
In general, trading currency options can be a good way to protect yourself from changes in exchange rates. Institutions, importers, and exporters all hedge to increase profits or reduce losses resulting from interest rate fluctuations.
? Trading/Speculating
Traders and speculators engage in currency derivative contracts to profit from transient changes in the foreign exchange markets. To increase their earnings, they could use a variety of tactics.
? Arbitrage
Certain markets allow traders to profit from differences in the price of a certain currency pair across other markets. This tactic, known as currency arbitrage, involves the buyer purchasing a currency pair and immediately selling it at a higher price.
Types of Currency Derivatives
The two most traded forex derivatives in India are exchange-traded derivatives, currency futures, and currency options. The institutions could also deal in less common contracts, such as currency swaps. But we will go into detail about the types of currency derivatives—futures and options, as that's what the retail segment trades most of the time.
- Currency Futures: With these contracts, you can lock in a fixed exchange rate and purchase or sell a predefined amount of the underlying currency at a later time. You must settle the contract if you keep holding it past the agreed-upon deadline.
- Currency Options: Similar to other option contracts, currency options give the option buyer the right to buy or sell some of the underlying assets at a defined exchange rate at a later time. But much like with futures, the deal is settled in INR if the option buyer decides to exercise the agreement.
Call options and put options are the two different types of options contracts; the former allows the options buyer to purchase the underlying asset, while the latter allows them to sell it.
- Currency Swap: The interest rate that a lender imposes in one currency can be changed for another with a currency swap. Institutions (sometimes called institutional investors) generally trade swaps, which are sophisticated derivatives, over the counter.
Trading In Currency Derivatives: How To Do It?
Currency derivatives are exchanged on the BSE, NSE, and national stock exchanges. Similar volumes exist on the Indian market exchange, the Metropolitan Stock Exchange, but they are significantly smaller than those of the BSE and NSE. Broker services can be used to trade currency derivatives.
Generally speaking, all significant stock broker companies offer currency trading services. Trading in currency derivatives is quite similar to trading in equity and derivatives. Using the trading app provided by the broker is feasible. A dollar-rupee contract only requires a 2-3% margin to be traded despite having a good contract size.
Conclusion
For individual investors, currency trading represents one of the most lucrative investment opportunities. It provides a closed, opaque market where most banks and financial institutions transact. Currency derivatives consultants and the foreign exchange-based currency derivatives industry are transparent and regulated. So, feel free to trade forex derivatives.