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Useful articles for your finance management by our team of experts

derivative strategies to trade in currency market

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On 19th June, 2013 rupee touched historic low of Rs 60 to a dollar due to an indication of a gradual end to the stimulus package given by US Federal Reserve. This news led to sharp depreciation in rupee against dollar and adds to the misery of government / Reserve Bank of India. In the month of June, 2013 rupee slid from Rs 56.7 to Rs 59.6 against dollar. Speculators / traders booked profits by trading in currency futures market. In this article, we will discuss two derivative strategies to trade in currency market. One strategy leads to booking profits when rupee is depreciating, while other is useful when rupee appreciates against the dollar. So, understanding market scenario and applying suitable strategy will help in booking profits while trading in currency futures market.   

 

derivative strategies in currency market 

Strategy 1: Long Position in Futures

 

Meaning:

Buying futures contract in anticipation of strengthening of the base currency (USD) and selling the terms currency (INR).

 

Applicable:

When rupee is depreciating against dollar

 

Risk and return matrix:

  • Unlimited profit if rupee depreciates against dollar as analysed.

  • Unlimited loss if rupee doesn’t depreciate against dollar as expected and trader doesn’t choose to exit from his position.

 

Example

Mr Abhishek Jaju, an active trader in currency futures market analysed macro and micro economy scenario. He then anticipated that INR would depreciate against USD in short term led by widening of current account deficit, increase in oil imports at high prices and an announcement from US Federal Reserve to end stimulus package. Based on the analysis, on 2nd May, 2013 he decided to buy 1 USD/INR August futures contract at the prevailing rate of Rs 53.80. He had decided to hold the contract till expiry and rupee depreciated in month of May as per his anticipation due to factors discussed. On 30th May, 2013 USD/INR was trading at Rs 56.37, so he booked profit of Rs 3,070 (56.37 x 1000 – 53.8 x 1000) on 1 futures contract.

  

Squaring off Long position in futures contract of USD/INR between (2nd May – 30th May, 2013)

squaring off long position in futures

Mr Abhishek analysed the economy scenario / market conditions and took the right call of buying long position in futures contract. This led to profit of Rs 3,070 from one futures contract of USD/INR.

 

Strategy 2: Short Position in Futures

 

Meaning:

Selling a futures contract in anticipation of weakening of the base currency (USD) and buy the terms currency (INR).

 

Applicable:

When rupee is appreciating against dollar

 

Risk and return matrix:

  • Unlimited profit if rupee appreciates against dollar as analysed

  • Unlimited loss if rupee doesn’t appreciate against dollar as expected and trader doesn’t choose to exit from his position

 

Example

Traders / Speculators are expecting RBI to intervene to halt depreciation of rupee against dollar. There are some measures and actions expected from RBI which will not led to further depreciation of rupee. Analysts expect rupee to appreciate around Rs 55 per dollar in the next 3 to 6 months.

 

 

Assume considering such scenario, on 1st Jul, 2013 Mr Abhishek Jaju decides to sell 1 USD/INR July contract at the rate of Rs 59.8.  In first week of July, RBI announces some measures and rupee has started appreciating as expected. On 15th Jul, 2013 rupee appreciated to Rs 57.6, so he decides to square off his short position in 1 USD/INR Jul futures contract and earns a profit of Rs 2,200 (59.8 x 1000 – 57.6 x 1000).

 

 

Here, Mr Jaju has analysed market conditions and took a right decision of going short on futures which led to book profit of Rs 2,200 per contract with small investment i.e. margin money as decided between a broker and trader.

 

Conclusion

Trading in futures market will expose you to high risk and high return matrix. So, enter in this market with thorough research before buying or selling a futures contract. Don’t be greedy when you are making profit from contract you entered. Make an appropriate exit from contract by squaring off your position when you are in loss.

 

About the Author:

Hiral Thanawala is a PGDM (Finance) graduate and Certified Financial Planner with an experience of over 5 years in equity market and personal finance domain. The views explained by him are personal. He can be reached at

expert@investmentyogi.com


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