Indian importers prefer currency options as rupee holds steady, premiums rise By Reuters

By Nimesh Vora and Jaspreet Kalra

MUMBAI (Reuters) – Indian importers are exploring options strategies to hedge against currency risks amid reduced rupee volatility, moving away from forward contracts that have become expensive, traders said.

Premiums, which reflect the interest rate differential between the United States and India, rose as the Federal Reserve is expected to begin a rate-cutting cycle starting next week.

“With the significant increase in forward premiums, we recommend that importers consider option structures,” said Samir Lodha, managing director at foreign exchange consultancy QuantArt Market Solutions.

The 1-year dollar/rupee forward premium rose nearly 75 basis points in the past two months to a 16-month high, making it more expensive to hedge future payments in the currency.

With high premiums and low volatility, option structures such as capped forwards are recommended, according to QuantArt’s Lodha. The cost of using a capped forward is about 55%-65% less than using a forward.

Such structures would, for example, allow importers to lock in a foreign exchange payment due in six months at the dollar/rupee spot rate of 83.96, but the protection would only last up to 85, Lodha said.

This is where the relative stability of the rupee helps, as the likelihood of a large depreciation in a short period of time is low.

India’s central bank, which is active on both sides of the foreign exchange market – buying and selling dollars – has canceled out volatility, making the rupee among the least volatile currencies in Asia.

“Both implied and realized volatility remain extremely low, prompting importers to use option structures such as gulls, knockouts and range forwards to capture better returns in the current market environment,” Ashhish Vaidya, Managing Director and Treasurer, Global Financial Markets at DBS Bank. India, he said.

A knockout allows the importer to buy dollars at a better rate than in the forward market, but this benefit ends if the rupee depreciates beyond a predetermined level.

“There’s no denying that higher premiums are discouraging importers from hedging in the forward market,” leading to questions for option structures that are cheap, said a bank foreign exchange salesperson.