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Currency Derivatives: What to Know Before You Venture In

Currency derivatives are available on four currency pairs: US dollar, euro, British pound and Japanese yen.
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Currency Derivatives: What to Know Before You Venture In

Currency derivative offer investors an option to trade in major foreign currencies pegged to the Indian rupee. Leading stock exchanges of India offer futures trading contracts in different foreign currencies. A currency future, also known as FX future, is a futures contract to exchange one currency for another at a specified date in the future at a price (exchange rate) that is fixed on the purchase date. 

 

Currency future contracts allow investors to hedge against foreign exchange risk and gain from two-way movement of rupee against other currencies. The trading volumes in the currency futures contracts have increased over the years, with daily average turnover jumping to Rs 12,705 crore on the NSE in 2014-15, from Rs 1,167 crore in 2008-09 when it was launched.

 

Currency derivatives are available on four currency pairs: US dollar, euro, British pound and Japanese yen.

 

How to Trade

 

Currency derivative contracts are traded in pairs like rupee-dollar, rupee-British pound and rupee-euro with a contract size of 1,000. The rupee-yen contract has a lot size of 1,00,000. For example, if the one dollar is at 62.4950, then the contract size will be at Rs 62,495 (62.4950*1000). 

 

These contracts are quoted till the fourth decimal point. For example, traders have a view that the dollar value will increase against the rupee, then they take a long position (buy) in the rupee-dollar contract.

 

If a trader buys a dollar derivative contract at rate of 62.4950, then the total contract value (lot size of 1,000) becomes Rs 62,495. Suppose, during the course of trade the rate of dollar moves up to 62.4951 then the contract value will jump to Rs 62,495.10. Hence, the upward or downward movement in the fourth decimal number results in a gain or loss of 10 paise for traders.

 

The currency pairs are available to traders at a margin which means they pay only some per cent value of the contract, rather than the full value, making it a lucrative trading option among the traders. The margins for these contracts are decided by brokers based on exchange guidelines. On an average, traders can buy the contracts by paying a margin of 3-5 per cent of the total value of the contract size.

 

Unlike stock and index future contracts, the contracts of the currency pairs expire two working days prior to the last business day of the expiry month at 12:30 pm.

 

The price fluctuations in the currency contracts have a linkage to the economic indicators of the particular country of which a person is trading the currency. Trade balance, inflation, interest rates and political risks affect the movement of the currency futures contracts.

 



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