Currency derivatives are not for retail investors

Though 4-6 per cent returns are on par with bank savings accounts and debt MFs, risks are higher.

Apoorva Kumar and his friends have been keenly reading reports on how investors are extending their bets in the Chinese yuan, the Singaporean dollar and the South Korean won.

Kumar, 21, has become inquisitive about the dynamics of investing through this route because he has some money saved from his summer job, besides the profits earned from his mutual fund investments. “With a year’s experience, we know that investing in a new asset class means diversifying risks. But we don’t know how to invest in currency and whether individuals can invest there,” explains the third-year engineering student from Bhubaneswar.
 

FOR CURRENCY INVESTMENT

• Do it through a broker in derivatives
• Contract’s tenure is up to one year
• Options are safer than futures, as they are hedge
• Contracts held for over six months are illiquid
• Returns are on a par with the savings rate, debt funds (4-6 per cent)

Experts say from the time stock markets have been volatile, many retail investors have been taking exposure in the currency market through derivatives, as one cannot directly buy or sell currencies in India.

But investors need to remember the currency derivative market is new in India. And, therefore, it is immature. The market was made open for retail investors in July 2008. At present, stock exchanges allow futures trading in the dollar, pound, euro and yen. Options are allowed in dollar-rupee only. You would need a trading account from a currency exchange-enabled broker.

You can invest in currency derivatives only through a broker. And, one contract size is worth $1,000 or Rs 45,000. The good part is the minimum investment requirement is lower than in equities.

Explains Aurobindo Prasad, head-commodity and currency, Karvy Commtrade, “For a dollar-rupee futures contract, you need a margin of three-five per cent or Rs 1,000-1,500. And, for a similar options contract, you need to pay a premium of Rs 190.” Add to this a brokerage charge of one-three paise per transaction, varying from one broker to another.

In comparison, the minimum trading amount required for equities is Rs 2 lakh. The margin money is also higher, upwards of 10 per cent, depending on the stock and the broker. There is a cap on the exposure you can take in the currency market at up to six per cent of the open interest or $10 million (Rs 45 crore), whichever is higher.

Currency derivative contracts are valid up to 12 months, apt for investment purpose. But it is a speculative market, used mostly for trading. And, liquidity can be an issue if you plan to hold on for over six months.

“Nearer the expiry, higher is the value you get, as predicting in the short term is easy. This market is sensitive to macro factors such as interest rate, which is hard to predict over a long term,” said Viral Shah, senior vice-president, Geojit Commtrade. For instance, the open interest for a dollar-rupee contract is 9.99 lakh on the National Stock Exchange today, at Rs 44.94 per dollar. However, the open interest for the same contract a year later is 2,540, at Rs 47.75 a dollar.

But, interestingly, experts say it works best as a portfolio diversifier. As for the returns, it is not great. Karvy Comtrade’s Prasad says, typically, currencies move in a fixed band.

Like, a dollar-rupee pair easily moves up four-six per cent in a year. This is similar to returns from a savings bank rate (four per cent) and debt mutual fund (up to six per cent), but has a lot more risk. Bank fixed deposits give much higher (nine per cent onwards) and equity mutual funds 12-15 per cent a year.

Plus, you need to track your investments because it is sensitive to all macro-economic factors globally — interest rate, inflation and gross domestic product. Any global cue makes a difference to your investments. And, this won’t be easy for retail investors without an understanding of the market. Mostly, high net worth individuals can invest with surplus cash, preferably through the options route, as it is a hedge instrument. Or, you could keep aside two-three per cent of portfolio for this purpose, without linking it to any goal.