Written by Nimesh Vora and Jasprit Kalra
MUMBAI (Reuters) – Indian importers are exploring options strategies to hedge against currency risk amid muted rupee volatility, moving away from outright futures contracts that have become expensive, traders said.
Insurance premiums, which reflect the interest rate differential between the US and India, have risen as the Federal Reserve is expected to begin its rate-cutting cycle, starting next week.
“With forward premiums rising significantly, we recommend importers to consider option structures,” said Sameer Lodha, managing director of foreign exchange consultancy Quant Art Market Solutions.
The one-year dollar/rupee yield premium has jumped about 75 basis points in the past two months to a 16-month high, making hedging against future foreign currency payments more expensive.
With premiums higher and volatility lower, options structures like capped futures are recommended, according to QuantArt’s Lodha. The cost of using capped futures is about 55% to 65% less than using futures.
Such structures would, for example, allow importers to book foreign exchange payments due within six months at the dollar/rupee spot rate of 83.96, but the protection would be valid only up to 85, Lodha said.
This is where the relative stability of the rupee comes into play, as the possibility of a significant decline in its value within a short period of time is low.
The Indian central bank, which is active on both sides of the foreign exchange market – buying and selling dollars – has managed to limit volatility, making the rupee among the least volatile currencies in Asia.
“Imposed and realized volatility remains very low, prompting importers to use option structures such as seagulls, knockouts and ranged futures to achieve better returns in the current market environment,” said Ashish Vaidya, Managing Director and Treasurer, Global Financial Markets, DBS Bank India.
The knock-on allows the importer to buy dollars at a better price than the prevailing rate in the forward market, but this benefit stops if the rupee falls below a predetermined level.
“There is no denying that high insurance premiums prevent importers from hedging in the forward market,” said a foreign exchange sales representative at a bank, prompting inquiries about lower-cost options structures.