5 Advantages of Currency Derivative Trading

 

Trading in the Indian Stock Market can be done through various manners. While some choose to buy and sell stock/shares, there are others who choose to trade through derivatives.

Derivatives are basically financial instruments or contracts which base their value on the performance of spot market price, (also known as the underlying variable market conditions such as bond, stock or currency. These underlying market conditions may be interest rates, market indexes, equity prices, currency exchange rates, market securities and credit. These transactions can be of different types such as futures, options, swaps, floors, caps, collars, structured debt obligations and deposits, forwards; or any combination.

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Derivative Trading in India usually takes place on a separate/individual derivative exchange/a separate segment of an existing stock exchange.

There are two types of derivative instruments which are traded at the NSE;

Futures: This is an agreement between two parties, either to buy or sell a particular asset at a certain time in the future at a certain price. Future contracts are usually settled in cash. These are particularly used in the commodities market. Future contracts are always denominated in a particular currency; where the purchase a speculation for the value of the commodity as well as the currency in which the contract is made.

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Options: This is a contract where the investor has the option - not an obligation to buy or sell an underlying at a future stated date at a pre-determined price. They may be of two different types:

- Calls: These give the buyers the right (not an obligation) to buy a particular given quantity of the 'underlying asset' at a particular price; either on or before a pre-decided date.

- Puts: These give the buyers the right (not the obligation) to sell a particular quantity of an underlying asset at a particular price; either on or before a pre-determined date.

All option contracts are settled in cash

There are two categories of derivative contracts:

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1) Over-the-counter (OTC) derivatives: These types of derivatives do not trade on formal stock or future exchanges or through a centralized counterparty. They may be either:

2) Exchange-traded derivatives: These types of derivatives are traded through specialized derivative exchanges or any other exchange.

The foreign currency market, which is the largest trading market in the world, is also known as 'FX' or 'Forex'.

This market is based on trading on currencies. This market trades currency derivatives - financial instruments which are based on foreign currency.

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What are Currency Derivatives?

These are types of contracts where currencies are traded in the form of futures or contracts and can be traded as assets in their own right. Investors who choose to buy future contracts in currencies are buying the right to exchange a certain amount of a particular commodity at a future date. The currencies used in currency future trading include US Dollar-Indian Rupee (USDINR ), Euro-Indian Rupee (EURINR ), Japanese Yen-Indian Rupee ( JPYINR ) and Pound Sterling-Indian Rupee (GBPINR ). Exchanges such as USE, SX, and MCX-SX provide currency trading in India. Hedging

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This type of trading usually involves the following parties:

· Traders-importers/exporters

· Arbitrageurs

· Speculators

· Hedgers

· Stockists

5 Advantages of Currency Derivatives Trading

1. Hedging: Hedging basically refers to making an investment where you can reduce the risk of price movements in an asset. You can not only protect your foreign exchange exposure but also hedge potential losses by taking necessary positions for the same. For e.g. you could hedge if you had a feeling that the USDINR was going to depreciate.

2. Speculation: Speculation refers toengaging in risky financial transactions with an attempt to make profits from short or medium term fluctuations in the market value of a tradable good. For e.g. If you expect that oil prices would rise in the future, impacting India's import bill; accordingly you could buy USDINR in expectation that the INR rate would depreciate.

3. Leverage: Leverage basically refers to the use of different financial instruments or borrowed capital such as margin so as to increase the potential return of an investment. By trading in currency derivatives by just paying a % value known as the margin amount instead of the full traded value.

4. Arbitrage: Arbitrage refers to the process of purchasing and selling the same security; at the same time in different markets (BSE & NSE). This is done to take advantage of a price difference between the two separate markets.

5. Style of Trading: There is transparent online trading and no insider trading involved in currency trading

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