The Securities and Exchange Board of India (Sebi) is in talks with the Reserve Bank of India (RBI) to introduce foreign currency options on the exchanges.
Sources close to the development told Business Standard that a seven-member standing committee, with representatives from both Sebi and RBI, is working on the modalities to bring in foreign currency options by October this year.
The move assumes a huge significance in view of the heavy losses that companies had incurred in overseas cross-currency options deals last year. Standardised and exchange-traded currency options are at least regulated.
“Currency options will benefit a large number of exporters and importers who often take huge currency risks on their contracts. Small and medium cap enterprises essentially need products like currency options to hedge their exposure to foreign currency rates. The RBI-Sebi committee on currency derivatives is looking at ways to help these SMEs to effectively hedge their exposure and avoid taking large hits due to rate fluctuations. The guidelines should be ready by October,” said a source close to the development.
A foreign currency option is a contract between two parties that gives the buyer of the option the right to exchange a specified amount of one currency for another currency at a given foreign exchange rate on a specified future date.
A currency option involves the payment of a premium (the cost of the option) by the buyer to the seller. These instruments are used to protect foreign currency exposures against adverse currency movements and uncertain forex risks, keeping the cost of hedging low.
Since the risk of selling an option is unlimited, mostly banks would be able to sell the options. The seller gains cash through premiums. Unlike futures, the buyer of an option is not obliged to exercise the option contract on expiry.
A six month wait may indicate that, by October, the markets would have gained more depth and banks would become more active.
Exchange-traded currency options are favoured as they are transparent and contracts are standardised, while ensuring guaranteed settlements.
At present, only currency futures are traded on exchanges. The source said that the proposed currency options may be introduced with lot sizes similar to that of futures, i.e. $1,000. Initially, currency options are likely to be introduced in US dollar-rupee contracts.
Though the margins and open position limits are yet to be finalised for exchange-traded currency options, the source added that these limits may replicate that of currency futures to begin with. Sebi has recently increased the gross open position limits of currency futures clients to 6 per cent of the total open interest or $10 million, from $5 million earlier.
For non-bank trading members, the limits were enhanced to 15 per cent of the total open interest or $50 million, whichever is higher, from 15 per cent or $25 million earlier.
In an effort to improve the forex derivatives market, the central bank has been making efforts to introduce interest rate futures as well.
