According to four forex traders who spoke anonymously to NDTV Profit, currency traders in India’s foreign exchange market are seeing a decline in the dollar-rupee pair as the Reserve Bank of India intervenes aggressively to keep the rupee stable. He says he chooses to trade options in an unusual way.
This lucrative but risky trade strategy is likely to burn a hole in the pockets of market players if the rupee comes under pressure, it added.
The Indian rupee has been trading in a narrow range of $83.25-$83.40 to the dollar for the past four months due to the central bank’s aggressive two-sided intervention in the foreign exchange market.
According to the traders cited above, due to the lack of significant trading opportunities in the spot market, currency traders are turning to exotic foreign exchange options trading to make profits. They added that this accumulation of risks would result in significant financial losses in the event of any external shock in the future.
Exotic options are option contracts that have a different payment structure, expiration date, and strike price than traditional options. These options can be customized to suit an investor’s risk tolerance and desired return.
Exotic options provide flexibility but do not guarantee a profit.
Current options include knock-in and knock-out trades. These are options that activate or expire whenever the rupee reaches a certain level against the dollar.
On the National Stock Exchange, open interest in the most active options expiring on Dec. 29 (strike price $83.25) stood at 6.23 billion contracts as of Friday. According to the aforementioned trader, contracts of 300,000 contracts or more are considered high interest rates. NSE accounts for the largest volume of currency futures and options trading.
A senior forex trader at a large private bank said on condition of anonymity that some banks are selling call options on the dollar-rupee currency pair because the spot rupee volatility in 2023 is lower than the option’s implied volatility. He said he was there.
On Friday, the rupee closed at Rs 83.21 against the dollar, ensuring that options sellers made a profit.
active intervention
The RBI has kept market players somewhat satisfied through its aggressive interventions over the past few months. Therefore, they are encouraged to indulge in trades where risks are negligible and they can earn premium without incurring losses, said a private bank trader quoted above.
The risk is increasing, the official added.
Vikas Bajaj, head of currency derivatives at Kotak Securities, echoes this view.
“At first glance, this may not be a very alarming situation as long as volatility is well contained and positions follow yield for a short period of time, but if for some reason volatility picks up sharply and there are fluctuations, things get worse. “There is a possibility of “compression of volume (volatility),” Bajaj said.
Market participants do not expect the rupee to cross 83.75 rupees to the dollar in the short term.
The RBI bought $36.7 billion and sold $36.9 billion in the spot market in October, according to the central bank’s latest monthly report. According to the data, RBI’s currency futures position in October was $4.2 billion.
Since then, the central bank’s headline foreign exchange reserves (not taking into account the forward book) have increased by $29 billion, to $615 billion in December.
According to Dheeraj Nimu, an economist at ANZ Research, the RBI’s foreign exchange intervention is aimed at curbing rapid fluctuations in foreign exchange rates, but since “foreign exchange reserves are the first line of defense,” it is unlikely that currency manipulation will continue. This is to ensure a strong buffer.
“It’s very clear that they want to keep optical reserve numbers in place,” Nim said. “This means we don’t want to use up much of our spot reserves in case there is selling pressure on the rupee.”
“Secondly, the series of cash, futures and futures interventions in India is to manage market expectations and check domestic liquidity,” he added.
These spot dollar sales were followed by similar interventions in the dollar-rupee forward market to neutralize the impact on system liquidity, which was already in the red. As of Thursday, the system liquidity was in a deficit of Rs 2,680 crore, according to RBI data.
new threat
Rising tensions in the Middle East and recent attacks in the Red Sea have resurfaced concerns about rising oil prices. Traders cited above said the rupee is likely to come under pressure in the future if Brent crude oil prices rise to near $100 a barrel.
Brent crude oil futures on the Intercontinental Exchange traded at $79.63 per barrel on Thursday, compared to $79.54 per barrel on Wednesday. Brent crude oil hit a low of $73.52 on December 12, before the Houthi attack on the Red Sea last week.
According to the people cited above, geopolitical uncertainty and an aggressive rate hike cycle by the US Federal Reserve in 2023 will prompt the RBI to move forward with large-scale foreign exchange transactions through spot, futures and futures markets. It was decided to implement an intervention.
The RBI’s futures book turned negative in October to $14.6 billion due to swap transactions. This means that the central bank will have to sell this amount at a later date.
According to this calculation, the RBI’s foreign exchange reserves would effectively be $600 billion after taking into account the net futures short position held by the central bank. Analysts expect market regulators to continue adopting a three-pronged approach next year: curbing dollar inflows, maintaining rupee stability and strengthening foreign exchange vaults.
Traders said the fact that the Indian rupee is one of the strongest in Asia against the dollar gives the Reserve Bank of India room to continue buying dollars.
