Authors: Nimesh Vora and Jaspreet Kalra
MUMBAI (Reuters) – Indian importers are exploring options strategies to hedge currency risks amid low rupee volatility, shifting away from futures contracts that have become exorbitant, traders said.
Premiums, which reflect the interest rate differential between the United States and India, have risen sharply as the Federal Reserve is likely to begin a rate-cutting cycle starting next week.
“In view of the significant increase in term premiums, we recommend importers to consider option structures,” said Samir Lodha, managing director of forex advisory firm QuantArt Market Solutions.
The one-year dollar/rupee forward premium has risen almost 75 basis points in the past two months to a 16-month high, making it more exorbitant to secure future payments in foreign currencies.
With high premiums and low volatility, it’s advisable to employ option structures such as forward limit contracts, according to Lodha of QuantArt. The cost of using forward limit contracts is about 55%-65% lower than using forward contracts.
Such structures would, for example, allow importers to lock in a foreign currency payment due in six months at the dollar/rupee market rate of 83.96, but the protection would be valid only up to age 85, Lodha said.
This is where the relative stability of the rupee comes in handy as the likelihood of a significant depreciation in the near term is low.
The Indian central bank, which is busy on both sides of the currency market – buying and selling dollars – has curbed volatility, making the rupee one of the least volatile currencies in Asia.
“Both implied and realised volatility remain exceptionally low, prompting importers to use option structures such as seagulls, knockouts and range forwards to get better payouts in the current market environment,” said Ashhish Vaidya, Managing Director and Treasurer, Global Financial Markets, DBS Bank India.
A knockout allows the importer to buy dollars at a better rate than in the futures market, but this benefit disappears when the rupee depreciates below the agreed level.
“There is no denying that higher premiums are discouraging importers from hedging in the futures market,” leading to inquiries about low-cost options structures, said a foreign exchange representative at one bank.
