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About NISM CPE
2
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Instructions
3
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Disclaimer
4
⚫This presentation is made for the purpose of use by our
trainers for the sessions and for the benefit of
participants.
⚫NISM does not endorse the views and opinions
expressed by the trainers.
⚫NISM will not be held responsible for any personal
opinionsexpressed by the trainers.

Agenda
5
 Introduction to currency markets and derivatives with focus on currency
futures (90 minutes)
 Introduction to currency options (90 minutes)
 Currency options strategies and their payoffs (60 minutes)
 Trading, Clearing & Settlement and Regulations (90 minutes)
 Evaluation Test (30 minutes)

Introduction to currency markets
and derivatives with focus on
currency futures
6
Session 1
Duration: 90 minutes

Key concepts – time zones, currency pair, price quotations
7
 Currency pair
 Unlike other financial products, currency price is always relative to other currency.
There is no standalone currency price
 Ex: USD price differs when quoted against EUR and when quoted against INR
 Base Currency (BC) / Quotation Currency (QC)
 The BC is the currency that is priced and its amount is fixed at one unit. The other
currency is the QC, which prices the BC, and its amount varies as the price of BC
varies in the market. What is quoted throughout the FX market anywhere in the
world is the price of BC expressed in QC
 Example: In USDINR, USD is base currency and INR is quotation currency
 USD is the universal base currency, except when it is paired with AUD, NZD,
GBP, EUR and CAD.

Key concepts – market structure, two way quotes
8
 Interbank market vs. merchant market
 Market maker vs. Price taker
 Market maker quotes price for both buying and selling while price taker only
quotes either for buying or for selling
 In currency markets, banks are market makers
 Understanding two way price quotes
 Ex: USDINR: 69.05/ 69.07. Prices are quoted from market maker’s perspective
 Market maker is there to buy at 69.05 (bid) and willing to sell at 69.07 (offer)
 Narrower the difference between bid and offer, better is the price
 Price quotation norm: two decimal, four decimal

Peculiarities of Indian market
9
 Price benchmarks
 Interbank rate (IBR): Price at which banks are willing to transact amongst each
other
 RBI reference price
 OTC market timing for currency pair involving INR
 9:00 AM to 4:30 PM for merchant trades
 9:00 AM to 5:00 PM for interbank trades
 Price discovery of USDINR spot rate
 USDINR traded only in India and during 9 AM to 5 PM
 Price opens with a gap incorporating overnight market developments

FBIL Reference Rate
10
 The reference rates for USDINR and other major currencies are computed
and disseminated by the Financial Benchmarks India Private Limited (FBIL).
 FBIL is recognised by Reserve bank of India as an independent Benchmark
administrator and has assumed the responsibility of computation and
dissemination of reference rate for USDINR and exchange rate of other major
currencies with effect from July 10, 2018.
 FBIL reference rate is calculated for USDINR, GBPINR, EURINR and JPYINR.
 The USDINR reference rate is calculated based on actual spot USDINR
transactions taking place on the electronic platforms such as CCIL and
Thomson Reuters between 11:30 to 12:30 hourson each working day.
 The EURINR, GBPINR and JPYINR reference rates are computed by crossing
the USDINR reference rate of the day with the ruling EURUSD, GBPUSD and
USDJPYspot rates.
 Reference rates of USDINR, EURINR and GBPINR are published up to 4
decimal places and JPYINR referencerate up to 2 decimal places.

Key concepts- settlement/ value date
 Generally, in OTC currency market, settlement of a trade is by exchange of
currency and not by exchange in value of currency
 The settlement could happen on any day after the transaction and these days
are called as: Cash, tom, spot, forward
 Please note that T+1 and T+2 refers to one and two business days after
transaction date
 Default settlement is for value “spot”
Trade date and
also cash date
Tom Spot
T T+1 T+2
Forward
11

Exchange rate arithmetic - EURINR
12
 Cross rate: Method of arriving at a price for a currency, by crossing rates of
two currency pairs
 Ex: EURINR price can be arrived at by crossing prices of EURUSD and USDINR.
Assume EURUSD price is 1.0925 / 1.0950 and USDINR price is 68.02 / 68.03
 We could build a chain of buy, sell transactions to arrive at EURINR price
 In EURINR, EUR is base currency and we have to price one unit of EUR in
terms of INR. As per the example, price of one unit of EUR is only available in
USD. Therefore, we have to first sell INR to buy USD and then sell USD to
arrive at buying price of one unit of EUR. Please note prices will be taken
from market maker’s perspective. The working is as follows:
 EURINR=1.0950 x 68.03= 74.4929 ; similarly price for selling one unit of EUR
would be 1.0925 x 68.02=74.3119 . Thus two way EURINR price would be
74.3119/ 74.4929.

Exchange rate arithmetic - JPYINR
13
 Assume USDJPY price is 120.60 / 120.61 and USDINR price is 68.02 / 68.03.
 In JPYINR, the norm is to quote value price for 100 JPY
 We could build a chain of buy, sell transactions to arrive at JPYINR price
 We have to first sell INR to buy USD and then sell USD to arrive at buying
price of one unit of JPY. Please note prices will be taken from market maker’s
perspective. The working is as follows:
 Given the above pries, USD can be bought at price of 68.03 by selling INR. And by
selling one USD, you could receive 120.60 JPY. Thus price of buying 120.60 JPY is
68.03 INR. However, we have to find price of buying 100 JPY.
 Therefore price of buying 100 JPY= 100 x 68.03 / 120.60 =56.41 and price of
selling 100 JPY is 100 X 68.02/120.61 = 56.40. From market maker’s perspective
price of JPYINR would be 56.40 / 56.41.

Factors impacting currency prices
14
 Just like how the equity prices are linked to fundamental strength of the
company, similarly in very long term, price of one currency versus other is
linked to relative economic strength of the country
 In short term, factors like demand supply mismatch, global risk appetite,
important political events etc may determine currency price
 At any point of time there may be multiple factors impacting currency price
with some factors indicating appreciation while others indicating
depreciation. It is important to assess all these factors, which are the
dominating factors at a point in time and accordingly form view on prices

Factors impacting currency prices – economic indicators
15
 Important economic indicators
 GDP growth: Higher growth rate would mean currency appreciation
 Inflation: In long term, high inflation may result in currency weakening. But in
short term it may result in appreciation on account of inflows in debt market
 Interest rate scenario: Same impact as of inflation
 Retail sales: It is a leading indicator of state of economy and a positive
number may mean currency appreciation
 Index of industrial production: It is a leading indicator of state of economy
and a positive number may mean currency appreciation
 Unemployment %: Low unemployment is good for currency valuation
 Outcome of important meetings like central bank meeting

Brief introduction to derivatives - futures
16
⚫ Derivative is a product whose value is derived from the value of one or more
basic variables, called bases (underlying asset, index, or reference rate). The
underlying asset can be equity, foreign exchange, commodity or any other
asset. For example, wheat farmers may wish to sell their harvest at a future
date to eliminate the risk of change in prices by that date. Such a transaction
is an example of a derivative. The price of this derivative is driven by the spot
price of wheat which is also called as the "underlying“
⚫ A futures contract is a standardized contract, traded on an exchange, to buy
or sell a certain underlying asset or an instrument at a certain date in the
future, at a specified price. When the underlying asset is an exchange rate,
the contract is termed a “currency futures contract”
⚫ Currency futures are a linear product, and calculating profits or losses on
these instruments is similar to calculating profits or losses on Index futures

Difference between forwards and futures
17
 Futures and forwards offer the same economic function. However, futures
are standardised contracts with tight risk management structure and
forwards are customised with risk management left to counterparties
⚫ Advantages of Futures:
⚫ Price transparency
⚫ Elimination of Counterparty credit risk
⚫ Access to all types of market participants while OTC market is not open to all
⚫ Generally, futures offer low cost of trading as compared to OTC market
⚫ Limitations of Futures:
⚫ The benefit of standardization, though improves liquidity in futures, may lead to
imperfect hedge as amount and settlement dates cannot be customized
⚫ While margining and daily settlement is a prudent risk management policy, some
market participants prefer OTC forwards, where collateral is usually not the norm

Interest rate parity – basis of currency futures price
18
 Interest rate parity states that relative future value of one currency to
another is a function of interest rate differential between two countries
 Given below derivation of futures price of USDINR. Assume:
⚫ Spot exchange rate of USDINR is 68 (S)
⚫ One year future rate for USDINR is (F)
⚫ Risk free interest rate for one year in USA is 3% (RUSD)
⚫ Risk free interest rate for one year in India is 7% (RINR)
⚫ Money can be freely transferred easily from one country to another
 Investor borrows 1 USD in US for one year, converts it to INR and invests INR
for one year in India. After one year he sells INR to return the USD
borrowing. For no arbitrage, the amount of USD received after selling INR
should be equal to the amount of USD to be return in US after one year
⚫ S(1+RINR)= F(1+RUSD)
⚫ Or, F/ S = (1+RINR) / (1+RUSD)

Interest rate parity – basis of currency futures price
19
⚫ Therefore,
⚫ S x (1+RINR)= F x (1+RUSD)
⚫ Or, F/ S = (1+RINR) / (1+RUSD)
⚫ Using the values given above, the one year future value of USD would be:
⚫ F/ 68 = (1+.07) / (1+.03)
=> F = 70.6408
⚫ Approximately, F is equal to the interest rate difference between two
currencies i.e., F = S + (RINR - RUSD) x S
⚫ Key conclusion:
Future value of a currency with high interest rate is at discount to value of
currency with low interest rate or future value of a currency with low
interest rate is at a premium to value of currency with high interest rate

Interest rate parity – Illustration
20
⚫ Suppose 6 month interest rate in India is 5% (i.e., around 10% per annum)
and in USA are 1% (i.e., around 2% per annum). The current USDINR spot
rate is 68. What is the likely 6 month USDINR future price?
⚫ The futures rate could be calculated using the formula mentioned above
and the answer comes to 70.69.
⚫ F6months = 68 x (1+0.10/12 x 6) / (1+0.02/12 x 6) = 70.69
⚫ On an approximate basis, future rate could also be calculated as follows:
⚫ 6 month Futures value = Spot + 6 month interest difference
= 68+ 4% of 68 = 68+ 2.72=70.72

Concept of Premium/Discount – An illustration
21
⚫ Assume risk free interest rate in JPY is 0.25% and in EUR is 1%. Current
EURJPY spot rate is 123.4.
⚫ Would future value of EUR be at discount of premium to JPY
⚫ What is it likely to be: towards 124 or towards 122.

Basic futures strategies
22
⚫ Basic strategies – Long futures or short futures
⚫ Long futures: In this strategy you buy futures contract
⚫ Short futures: In this strategy you sell futures contract
⚫ Long position could be created by a hedger who has need to buy underlying
asset at a future point of time or by a speculator who thinks that price may
appreciate
⚫ Short position could be created by a hedger who has need to sell underlying
asset at a future point of time or by a speculator who thinks that price may
depreciate

Hedging strategies for various business needs of
23
hedgers
 Given below is hedging solutions that hedgers may use to hedge currency
price risk in various situations
 The amount and tenor of hedge would depend on amount of underlying
asset on which there is price risk and tenor for which price risk exists
Hedger's business context
Currency
need
Hedging
solution
An importer who has to make import
payment in future Buy USD
Long USDINR
futures
An exporter who has to receive export
payment in future Sell USD
Short USDINR
futures
A tourist who has to pay for his holiday in
USA Buy USD
Long USDINR
futures
A person in India who receives fixed USD
amount as family aid from his son in USA Sell USD
Short USDINR
futures
A person who has invested in US equities
and wants to hedge currency risk Sell USD
Short USDINR
futures
A person who has invested in physical gold
in India and wants to hedge currency risk Sell USD
Short USDINR
futures
A company which has to make repayment
of loan taken in foreign currency Buy USD
Long USDINR
futures

Pay off from using currency futures hedging strategies
24
for hedgers – USD buy need
 Business need: Buy USD in future
 Possible corporate need: Import payment, repayment of foreign currency
loan, Medical/ education/ tourism etc related payment in USD
 Example: An importer of edible oil buys 200 tons of oil at the price of USD
5000 per ton. On the day of finalizing the contract, USDINR spot price was 68.
The importer was not sure about the INR movement in future but he was
more biased towards INR appreciation. He decides to hedge half of the total
exposure using currency futures and contracted a rate of 68.50 using two
months futures contract. At the time of making import payment, bank makes
import payment at 69.50. On the day of making import payment, the futures
contract price was at 69.70.

Pay off from using currency futures hedging strategies for
hedgers – USD buy need
25
 What was the effective USDINR price for the importer and what would it
have been had he hedged the full exposure?
 Pay off from hedge transaction:
 Number of contracts to be bought to hedge half the exposure: 200 x 5000/
(1000 x 2) =500
 Pay off from difference in hedged price and settlement price = 69.70 - 68.50 =
1.20
 Therefore hedging pay off on 500 contracts = 500 * 1000 * 1.20 = 600,000
 Effective FX price = Price at which actual import payment made + pay off
from hedging i.e., 69.50 - 0.60 =68.90
 Effective price if entire import was hedged = 69.50 - 1.20 = 68.30.

26
for hedgers – USD sell need
 Business need: Sell USD in future
 Possible corporate need: Export realisation, Repatriation of gains/ capital
from foreign investment, receipt of aid/ grants etc
 Example: An exporter of iron ore from India has contracted to export 1000
tons of ore to steel company in Japan. The agreed price was USD 150 per ton
and the payment would be made three months after the shipment. The
exporter would take one month to process the order. The exporter had used
the prevailing spot price of 68 as the budgeted price while signing the export
contract. To avoid the FX risk, the exporter sells four month futures at the
price of 69. He receives export payment before time and he converts USD to
INR in the OTC market at the then prevailing price of 70 & at the same time
cancels the futures contract at 70.20.

27
for hedgers – USD sell need
 What was the effective currency price for the exporter?
 Pay off from hedge transaction:
 Number of contracts sold : 150 x 1000 / 1000 = 150
 Pay off from difference in hedged price and settlement price = 69 – 70.20 = -1.20
 Therefore hedging pay off on 150 contracts = 150 * 1000 * -1.20 = - 180,000
 Effective FX price = Price at which actual export realisation was made + pay
off from hedging i.e., 70.0 – 1.20 = 68.80.
 Note that under all circumstances (if fully hedged) exporter would always get
price of 68.80, assuming 20 paise difference between price at which USD is
converted to INR and price at which hedge is cancelled.

Investing gold in India – use of currency futures
28
 A person in India is keen to invest in gold with a view of rising gold prices
against USD. He invested via ETF gold contract which are exchange traded
and are priced in INR. After three months of his investment in ETF, gold
appreciated by 15% against USD while ETF appreciated by only 10%. The low
appreciation of ETF was because of appreciation in INR against USD. The
investor is contemplating ways to remove the USDINR risk in ETF contract
such that the investor is left only with gold related risk and related return
without worrying about USDINR fluctuations. How can he use currency
futures contract to de-risk his investment from currency price risk?

Repatriating funds from abroad - use of currency futures
29
⚫ A person has invested USD 100,000 in US equities with a view of appreciation
of US stock market. In next one year, his investments in US equities
appreciated in value to USD 115,000. The investor decided to sell off his
portfolio and repatriate the capital and profits to India. However, at the time
of converting USD to INR, he received an exchange price of 64 as against 67
which was the price at which he had converted INR to USD at the time of
investing abroad.
⚫ Let us answer few questions using this example:
⚫ What is investor’s return on capital in USD and INR? What would be his return in
INR if it had depreciated to 70 at the time of converting USD to INR?
⚫ What could have investor done to de-risk his portfolio from currency risk?

Repatriating funds from abroad - use of currency futures
30
 A. Computing returns in USD :
 Amount invested = USD 100,000; Amount received by liquidating = USD 115,000
 Return in USD = (115000-100000)/ 100000 = 15%
 B. Computing returns in INR :
 Amount invested = 100,000 x 67= INR 6,700,000;
 Amount received by liquidating = 115,000 x 64= INR 7,360,000
 Return in INR = (7,360,000-6,700,000)/ 6,700,000 =9.85%
 C. Computing returns in INR, if it had depreciated to 70:
 Amount invested = 100,000 x 67 = INR 6,700,000;
 Amount received by liquidating = 115,000 x 70= INR 8,050,000
 Return in INR = (8,050,000-6,700,000)/ 6,700,000 =20.15%
 D. Hedging strategy to de-risk portfolio from USDINR price risk :
 Short USDINR
 The computation would be same as that for an exporter

Limitation of currency futures for hedgers
31
 May result in imperfect hedge
 Futures contract specifications may not match exact tenor and amount of
underlying exposure
 Mode of settlement is not by delivery of currency
 Exposes to basis risk

Pay off for speculators in currency futures
32
 Speculators take view on direction of movement of currency/ currency
futures price and hope to profit from it
 USDINR one month futures price is quoting 70.40/70.41 and spot at
70.00/70.01. A speculator believes that INR appreciates against USD in
coming days on account of increased FII inflow in Indian debt and therefore
USDINR one month future price should come down. He shorts 100 lots. After
one week, spot trades at 69.88/69.89 and one month futures at 70.24/70.25.
He squares off the transaction. How much profit/ loss did he make
 Price at which futures was shorted = 70.40
 Price at which it was squared off = 70.25
 Total profit = 100 x 1000 x (70.40-70.25) = INR 15,000
 Net profit would be calculated after deducting transaction costs like brokerage,
taxes, etc.

Pay off for arbitrageurs in currency futures
33
Simple Arbitrage
 Suppose 6-month USDINR currency futures was trading at 65.98/66.00 while 6-
month forward in OTC market, for same maturity as that of currency futures
contract, was available at 65.85/65.86.
 Arbitrageur can short currency futures at price of 65.98 and go long in currency
forward at 65.86.
 At the time of settlement, trader loses 1.02 on futures and makes a profit of 1.14
on OTC forward contract. Thus he makes an arbitrage profit of 0.12 per USD.
 Please note that this arbitrage profit would have been constant at 0.12
irrespective of final settlement price as long as both OTC contract and futures
contract were settled at the same price.
 Since arbitrage gaps are small (a few basis points only), to save on transaction
costs and to reduce the shrinkages due to bid-ask spread, arbitrageurs prefer to
execute the trades through the brokers / exchanges / trading terminals which
offers prices at the least possible bid-ask difference and better liquidity.

Pay off for arbitrageurs in currency futures
34
Triangular Arbitrage
 Triangular arbitrage involves identifying and exploiting the arbitrage
opportunity resulting from price differences among three different currencies.
 It involves three trades: exchanging the first currency for a second currency,
exchanging the second currency for a third currency and exchanging the third
currency for the first currency.
 Triangular arbitrage is possible only when the exchange rates are not aligned
with the implicit cross exchange rate.
 Suppose EURUSD is available at 1.25, USDINR at 65 and EURINR at 80.65. An
arbitrageur who has 1000 EUR can exchange these for 1250 USD. He can
further exchange these 1250 USD for 81250 INR (USD 1250 * 65 INR per USD =
INR 81250). In the last leg of the triangular arbitrage, he can exchange 81250
INR for 1007.44 EUR thereby making an arbitrage profit of 7.44 EUR. Had the
EURINR been trading at 81.25 (instead of the 80.65 given in this example),
there could be no arbitrage opportunity. But for the given EURUSD and
USDINR rates, anything below 81.25 EURINR provides an arbitrage
opportunity.

Limitation of currency futures for arbitrageurs
35
 Since execution of arbitrage trade requires simultaneous buy and sell of a
contract, there is a loss of value in the form of bid-ask differences.
 Profitable arbitrage is very rarely possible because when such opportunity
arises, traders execute trades that take advantage of the imperfections and
prices adjust up or down until the opportunity disappears.
 Even when those opportunities appear for a very brief period of time, the
opportunity (price disparity) may be very small (around 1 basis point or so in
many cases) making it not a profitable opportunity after factoring in the
transaction costs and taxes.
 Moreover, there is also a risk of adverse price movement while the
arbitrageur is still setting up the arbitrage position.

Introduction to currency options
36
Session 2

Options – Definition, basic terms
37
 Option: The dictionary meaning of “Option” is ‘choice’ or ‘alternative’.
 Example: Paying initial token money to buy a house after three months
 Definition of option: It is a contract between two parties to buy or sell a
given amount of asset at a pre- specified price on or before a given date

38
⚫ The right to buy the asset is called call option and the right to sell the asset
is called put option
⚫ The pre specified price is called as strike price and the date at which strike
price is applicable is called expiration date
⚫ The difference between the date of entering into the contract and the
expiration date is called time to maturity
⚫ The party which buys the rights but not obligation and pays premium for
buying the right is called as option buyer and the party which sells the right
and received premium for it is called option seller/writer. Buying an option
is called as taking a long position, selling is called as taking a short position
⚫ The price which option buyer pays to option seller to acquire the right is
called as option price or option premium
⚫ The asset which is bought or sold is also called as underlying asset

39
 The above terms can be related to the example of an option of buying a
house by paying initial token amount.
⚫Does the above example constitute an option contract? If
yes:
⚫ Is it a call option or put option?
⚫ What is the strike price?
⚫ What is the expiration date?
⚫ What is the time to maturity?
⚫ Who is the option buyer and who is the option seller?
⚫ What is the option premium?
⚫ What is the underlying asset?
⚫ Buying car insurance is akin to buying a put option

Difference between futures and options
40
 In Futures, both buyer and seller have the right as well as under obligation
to buy or sell and therefore face similar risk
 In Options, the buyer has only rights and no obligations and therefore he
runs the risk of premium paid and option seller has only obligation and no
right and he runs unlimited risk

Option styles
41
 Based on the exercise time by the option buyer, options are classified as:
 European options: European options can be exercised by the buyer of the
option only on the expiration date. In India, only European currency options
are permitted.
⚫ American options: American options can be exercised by the buyer any time
on or before the expiration date. Currently American options are not
allowed in currencies in India.

Moneyness of option
42
 Moneyness of an option indicates whether the contract would result in a
positive cash flow, negative cash flow or zero cash flow for the option buyer
at the time of exercising it. Based on these scenarios, moneyness of option
can be classified into:
 In the money (ITM) option: An option is said to be in the money if on its
exercise, the option buyer gets a positive cash flow
 Out of the money (OTM) option: An option is said to be out of the money, if
on exercising it, the option buyer gets a negative cash flow
 At the money (ATM) option: An option is said to be at the money, if spot
price is equal to the strike price. Any movement in spot price of underlying
from this stage would either make the option ITM or OTM.

Option pricing
43
 The determinants of option price for currency options are as follows.
 Spot price of the underlying asset; Strike price
 Annualized volatility of the currency pair
 Time to expiration
 Risk free interest rate on base currency and quoting currency on date
Call Put
Spot FX rate ↑ ↓
Strike price ↓ ↑
Interestratedifferentialbetweenbaseandquotingcurrency ↑ ↓
Volatility ↑ ↑
Time to expiration ↑ ↑

Option value
44
 The option value comprises of three parts:
 Intrinsic value: The intrinsic value of an option is the difference between
spot price and the strike price
 Call option, the intrinsic value = Max (0, St-K), where K is strike price and St is
the spot price of the asset
 Put option, the intrinsic value = Max (0, K-St).
 Time value: The difference between option premium and intrinsic value is
time value of option. The time value is directly proportional to the length of
time to expiration date of the option The time value reflects the probability
that the option will gain in intrinsic value or profitable to exercise before its
maturity. Therefore higher time to expiration, higher the probability and
higher the time value.
 Please note that at expiry the option value is its intrinsic value and time
value is zero.

Currency options strategies and
their payoff
45
Session 3

Option payoffs
46
⚫ Payoff means return from the derivative strategy with change in the spot
price of the underlying
⚫ Option strategies result in non linear pay offs i.e., not a straight line but
either curve or a line with a sharp bend
⚫ Non linear pay off is because of option buyer has limited downside and
unlimited upside, while seller has limited upside and unlimited downside.
This is unlike returns from a futures contract or returns from a position in
cash market which are linear and are same for both buyer and seller

Option payoffs – diagrammatic representation
R
E
T
U
R
N
S
R
E
T
U
R
N
S
S p o t p r i c e
S p o t p r i c e
F i g u r e 1 : P a y o f f o f l o n g f u t u r e s c o n t r a c t F i g u r e 2 : P a y o f f o f l o n g c a l l
I T M
O T M
S t r i k e
P r e m i u m
R
E
T
U
R
N
S
S p o t p r i c e
F i g u r e 4 : P a y o f f o f s h o r t
f u t u r e s c o n t r a c t
R
E
T
U
R
N
S
S p o t p r i c e
O T M
I T M
A T M
P r e m i u m
F i g u r e 3 : P a y o f f o f l o n g p u t
B r e a k e v e n
B r e a k e v e n
A T M
S t r i k e

Option strategies
48
⚫ Four basic strategies:
⚫ Long call
⚫ Short call
⚫ Long put
⚫ Short put
⚫ These strategies can be used to execute different views on the market
⚫ Combination strategies: Above four strategies can be combined in multiple
ways to create customised option strategy

Long USDINR call: view of strong appreciation of USD
49
⚫ View: Assume that current USDINR spot is 64.5. Your view is that in next one
month, USD may strengthen and may trade around 66
⚫ Objective: You want to take full benefit of the view if it turns correct and at
the same time want to cap your losses if your view turns wrong
⚫ Option strategy: Considering this view, you bought a USD call option at
strike price of 65 and pay premium of Rs 0.6 per USD. If on maturity, USDINR
is above 65 you would exercise the option and buy USDINR at 65 and realise
an exercise profit equal to difference between then prevailing spot price and
65. However, the profit is partly offset by option premium of Rs 0.6. You
start making net positive cash flow for every price higher than 65.6 (also
called as breakeven point). At the same time, you would not exercise the
option if USDINR trades at or below 65 and in this case your loss is fixed at
Rs 0.6 which is equal to the premium paid. Between 65 and 65.6, your losses
gradually reduce from 0.6 to 0.

Long USDINR call: view of strong appreciation of USD
1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
50
64.0
64.2
64.4
64.6
64.8
65.0
65.2
65.4
65.6
65.8
66.0
66.2
66.4
66.6
66.8
67.0
67.2
⚫ Notice the non linear payoff
Payoff of a Long Call

Short USDINR call: view of moderately weak USD
51
⚫ View: Assume current spot as 64.5. Your view is that in next one month,
USD may weaken and will trade around 63.5 level. You also believe that if
USD strengthens, it will not strengthen above 65.
⚫ Objective: You do not want any cost to execute the view and rather want a
positive cash inflow to execute this view. You are comfortable to bear losses
if your view turn wrong and USD strengthens beyond 64.5.
⚫ Option strategy: You sell a USD call option at a strike price of 65 and receive
a premium of Rs 0.6 per USD. If on maturity, USDINR is at or below 65 the
option buyer would not exercise its right and hence you gain the premium.
However, if USDINR is higher than 65, the other party will exercise its right
and you would be obliged to sell USDINR at 65. Under this scenario, the
transaction gets into loss and losses increase with strengthening USD.

Short USDINR call: view of moderately weak USD
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
-1.0
-1.2
-1.4
-1.6
-1.8
52
64.0
64.2
64.4
64.6
64.8
65.0
65.2
65.4
65.6
65.8
66.0
66.2
66.4
66.6
66.8
67.0
67.2
⚫ For option seller, the losses are unlimited while profits are limited to the
premium received (Rs 0.6 per USDINR) irrespective of extent of market
movement
Payoff of a Short Call

Long put option: view of strong depreciation of USD
53
⚫ View: Assume current spot as 65.5. Your view is that in next one month,
USD may weaken and trade below 65
⚫ Objective: You want to take full benefit of the view if it turns correct and at
the same time want to limit your losses if view turns wrong
⚫ Option strategy: Considering the view and objective, you bought a USD put
option at strike price of 65 and paid a premium of Rs 0.6 per USD. If on
maturity, USDINR is below 65 you would exercise the option and sell USDINR
at 65 when spot price is lower than 65 . Therefore you realise an exercise
profit which is equal to difference between spot price and 65. However, this
profit is partly offset by the put option premium (Rs 0.6) that you have paid.
You start making net profit for every price lower than 64.4, which is the
breakeven point. At the same time, you would not exercise the option if
USDINR trades at or above 65 and in this case your loss is fixed and is equal
to the premium paid (Rs 0.6). Between 66 and 64.4, your losses gradually
reduce from 0.6 to 0.

Long put option: view of strong depreciation of USD
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
54
63.0
63.2
63.4
63.6
63.8
64.0
64.2
64.4
64.6
64.8
65.0
65.2
65.4
65.6
65.8
66.0
⚫ For option buyer, the losses are limited to premium paid (Rs 0.6) irrespective
of extent of market movement and his profits are unlimited
Payoff of a Long Put

Short USDINR put: view of moderately strong USD
55
⚫ View: Assume current USDINR spot to be 65.5. Your view is that USD may
strengthen and trade around 66.5 levels. You also believe that if this view
turns wrong, USD will not weaken below 65 as against current spot of 65.5.
⚫ Objective: You do not want any cost to execute the view and rather want a
positive cash inflow to execute this view. You are comfortable to bear losses
if view turns wrong and INR strengthens beyond 65.
⚫ Option strategy: You sell a USD put option at a strike price of 65 and receive
a premium of Rs 0.6 per USD. If on maturity, USDINR is at or above 65 the
other party (who has bought put option from you) would not exercise it and
hence you gain the premium. However, if USDINR is lower than 65, the other
party will exercise the option and you would be obliged to buy from him at
65 . Under this scenario, the transaction would start getting into loss. The
losses will keep increasing as USDINR keeps strengthening

Short USDINR put: view of moderately strong USD
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
-1.0
-1.2
-1.4
-1.6
56
63.0
63.2
63.4
63.6
63.8
64.0
64.2
64.4
64.6
64.8
65.0
65.2
65.4
65.6
65.8
66.0
⚫ For option seller, the losses are unlimited while profits are limited to the
premium received irrespective of extent of market movement
Payoff of a Short Put

Combination strategies
57
⚫ Combination strategies mean use of multiple options with same or different
strikes and maturities. Numerous strategies can be worked out depending
on the view on the market, risk appetite and objective
⚫ Various possibilities:
⚫ Call spread; Put spread
⚫ Strangle
⚫ Straddle
⚫ Butterfly
⚫ Covered Call; Covered Put

Bull call spread
58
⚫ View: Current USDINR spot is 64.5. Your view is that in three months it
should trade around 66 i.e., you have a moderately bullish view on USD.
⚫ Objective: You want to participate in the profits that would accrue if the
view turns correct and are also keen to reduce the cost of executing this
view. To reduce the cost, you are okay to let go of any profit that may accrue
to you beyond 65. In other words, you do not mind if your potential profits
are capped to reduce the cost. At the same time, you want to know how
much the maximum loss could be if view turns wrong.
⚫ Option strategy: You could buy an ATM or ITM call option for three months.
To reduce the cash payout resulting from option buying, you could also sell
an OTM call option for same maturity and partly offset the cost of buying
option by the premium received from selling a call option. The net cost
would be related to the distance between the strike prices

Bull call spread example
59
⚫ You buy an ATM call at strike of 64.5 and pay a premium of 0.75 INR (leg ‘A’ of
transaction). To reduce the cost of buying ATM call, you also sell a OTM call
with strike of 65 and receive a premium of 0.6 INR (leg ‘B’ of transaction)
⚫ Total cash outlay on account of premium is reduced from 0.75 to 0.15
⚫ Leg ‘A’ gets exercised and start resulting in profit when USD strengthens
beyond 64.5 and leg ‘B’ gets exercised and start resulting in losses beyond 65
⚫ Maximum net profit happens at 65 and is equal to 0.35. For any movement
below 64.5, none of the legs get exercised and the losses are limited to the
net premium paid which in this case is 0.15
⚫ For price move above, 65, both options are In-The-Money and the profit is
limited to 0.35

Bull call spread - payoff
⚫ Notice the limited losses and limited profit
⚫ R refers to net payoff of the strategy
-2.00
60
0.00
-0.50
-1.00
-1.50
1.50
1.00
0.50
2.00
61.90
62.50
63.10
63.70
64.30
64.90
65.50
66.10
66.70
Bull call spread payoff
R
B
A

Summary of Bull call spread
61
⚫ Maximum loss: Net premium paid. Maximum loss occurs when the spot
price is at or below lower strike price
⚫ Maximum profit: (higher strike price - lower strike price) - net premium.
Maximum profit occurs when spot price is at or above higher strike price
⚫ Breakeven point: (lower strike price + net premium) above which there will
be profit

Use of currency options – Case 1
62
⚫ A company exports mango pulp to Middle East region. It receives confirmed
orders 6 month in advance at a fixed price (USD/Tonne). Sometimes
company is not able to fulfill the order quantity as it is not able to buy
adequate amount of mango. As a practice, company hedges FX risk by
selling USD in futures market. In past company has faced huge losses on
account of FX hedging when it could not supply full order and USD
strengthened significantly against INR. What is the alternative hedging
strategy that company could use to avoid such losses?
⚫ Company could hedge part of its exposure using currency options - buy put.
It would ensure that company’s losses are limited to premium paid and not
beyond that

Use of currency options – Case 2
63
⚫ Assume there is an importer of edible oil in the country. The company
believes that because of increasing fiscal deficit in the country, reducing
portfolio inflows and political uncertainty there is high probability of USD
strengthening from current level of 65 to 66 in three months. However,
there is silver lining in Chinese Yuan strengthening and resulting in
strengthening of INR also (which is same as weakening of USD). Company
decides to hedge its USD payable via options. It is looking for an alternative
of cost lower than vanilla option.
⚫ Company could buy an ATM or ITM call option on USDINR and reduce its
cost by selling OTM call option. The actual strike would depend on
premiums and management objective.
⚫ Can you recollect what is this option strategy called?
⚫ This is called a bull call spread. Company could achieve a similar pay off
using put options and that strategy is called as bull put spread.

Trading, Clearing & Settlement and
Regulations
64
Session 4

Available for Trading: Currency Futures and Options
65
⚫ Currently, derivatives on the following currency pairs are traded in
Indian Currency Derivatives Exchanges:
⚫ INR Pairs: Futures and Options on USDINR, EURINR, GBPINR and JPYINR
⚫ FCY Pairs: Futuresand Options on EURUSD, GBPUSD and USDJPY
⚫ Also, weeklycontractsareavailable on USDINR currencypair

Contract Specification for INR Futures
Contract specification: USDINR, EURINR, GBPINR and JPYINR Currency Futures
Underlying Foreign currency as base currency and INR as quoting currency
Market timing Monday to Friday, 9:00 AM to 5:00 PM
Contract Size USD 1000 (for USDINR), EUR 1000 (for EURINR), GBP 1000 (for GBPINR) and JPY 100,000 (for JPYINR)
Tick Size 0.25 Paise (i.e., Rs 0.0025)
Quotation The contract would be quoted in Rupee terms. However, outstanding position would be in USD, EUR, GBP and
JPY terms for USDINR, EURINR, GBPINR and JPYINR contracts respectively
Contract trading
cycle
Maximum of 12 calendar months from current calendar month. New contract will be introduced following the
Expiry of current month contract.
Last trading day (or
Expiry day)
Two working days prior to the last business day of the expiry month at 12:30 pm. If last trading day is a trading
holiday, then the last trading day shall be the previous trading day.
Final Settlement
Day
Last working day (excluding Saturdays) of the expiry month. The last working day will be the same as that for
Interbank Settlements in Mumbai. The rules for Interbank Settlements, including those for ‘known holidays’
and ‘subsequently declared holiday would be those as laid down by FEDAI.
Settlement Basis Daily mark to market settlement will be on a T +1 basis and final settlement will be cash settled on T+2 basis.
Mode of Settlement Cash settled in INR
Daily Settlement
Price
Daily mark to market settlement price will be announced by the exchange, based on volume-weighted average
price in the last half an hour of trading, or a theoretical price if there is no trading in the last half hour.
Final Settlement
Price
FBIL reference rate

Contract Specification for FCY Futures
Contract specification: EURUSD, GBPUSD and USDJPY Currency Futures
Underlying In case of EURUSD and GBPUSD, the contract would be quoted in USD (i.e., EUR and GBP would be the base
currency and USD would be the quoting currency). The outstanding positions would be in EUR and GBP terms
respectively. In case of USDJPY, the contract would be quoted in JPY (i.e., USD would be the base currency and
JPY would be the quoting currency). The outstanding positions would be in USD terms.
Markettiming Monday to Friday, 9:00 AM to 7:30 PM
Contract Size EUR 1000 (for EURUSD), GBP 1000 (for GBPUSD) and USD 1000 (for USDJPY)
Tick Size 0.0001 USD for EURUSD & GBPUSD and 0.01 JPY for USDJPY
Contract trading cycle Maximum of 12 calendar months from current calendar month. New contract will be introduced following the
Expiry of current month contract.
Expiry day)
Final Settlement Day Last working day (excluding Saturdays) of the expiry month.
The last working day will be the same as that for Interbank Settlements in Mumbai. The rules for Interbank
Settlements, including those for ‘known holidays’ and ‘subsequently declared holiday would be those as laid
down by FEDAI.
SettlementBasis Daily mark to market settlement will be on a T+1 basis and final settlement will be cash settled on T+2 basis.
Modeof Settlement Cash settled in INR
Daily Settlement
Price
Final Settlement Price The final settlement price of the cross-currency derivatives contracts shall be computed using the FBIL
reference rate for USDINR and the corresponding exchange rate published by FBIL for EURINR, GBPINR and
JPYINR, as applicable, on the last trading day of the contract. For arriving at the final settlement value in INR
for EURUSD and GBPUSD contracts, the reference rate for USDINR on the last trading day of the contract
shall be used. For USDJPY contracts, the final settlement value in INR shall be arrived at using the exchange
rate published for JPYINR on the last trading day of the contract.

Contract Specification for Weekly Futures on USDINR
Contract specification: Weekly Futures Contracts on USDINR Currency Pair
Underlying USD as base currency and INR as quoting currency
Contract Size USD 1000
Quotation The contract would be quoted in Rupee terms (i.e., as INR Rupee per US Dollar), quoted upto the fourth
decimal place.
Contract trading cycle 11 weekly expiry contracts excluding the expiry week of monthly contract. New serial weekly futures
contract shall be introduced after expiry of the respective week’s contract.
Expiry day)
Every Friday of the week except for expiry week of monthly contract (during the expiry week of monthly
contract, the contract will expire on day of expiry of monthly contract). In case the Friday is a trading holiday,
the previous trading day shall be the expiry/last trading day.
Settlement Basis Daily mark to market settlement will be on a T+1 basis and final settlement will be cash settled on T+2 basis.
Daily Settlement Price Daily mark to market settlement price will be announced by the exchange, based on volume-weighted
average price in the last half an hour of trading, or a theoretical price if there is no trading in the last half
hour.
Final Settlement Price FBIL reference rate

Contract Specification for INR Options
Contract specification: USDINR, EURINR, GBPINR and JPYINR Currency Options
Contract Size USD 1000 (for USDINR), EUR 1000 (for EURINR), GBP 1000 (for GBPINR) and JPY 100,000 (for JPYINR)
Quotation The contract would be quoted in Rupee terms. However, outstanding position would be in USD, EUR, GBP
and JPY terms for USDINR, EURINR, GBPINR and JPYINR contracts respectively
Contract trading
cycle
3 serial monthly contracts followed by 3 quarterly contracts of the cycle March/June/September/December.
Expiry day)
Final Settlement
Day
Daily Settlement
Price
Final Settlement
Price
FBIL reference rate on the date of the expiry of the contact

Contract Specification for FCY Options
Contract specification: EURUSD, GBPUSD and USDJPY Currency Options
Underlying In case of EURUSD and GBPUSD, the contract would be quoted in USD (i.e., EUR and GBP would be the base
currency and USD would be the quoting currency). The outstanding positions would be in EUR and GBP terms
respectively. In case of USDJPY, the contract would be quoted in JPY (i.e., USD would be the base currency and
JPY would be the quoting currency). The outstanding positions would be in USD terms.
Markettiming Monday to Friday, 9:00 AM to 7:30 PM
Contract Size EUR 1000 (for EURUSD), GBP 1000 (for GBPUSD) and USD 1000 (for USDJPY)
Tick Size 0.0001 USD for EURUSD & GBPUSD and 0.01 JPY for USDJPY
Contracttrading
cycle
3 serial monthly contracts, followed by 3 quarterly contracts of the cycle March/June/September/December.
Expiry day)
Two working days prior to the last business day of the expiry month at 12:30 PM. If last trading day is a trading
Final Settlement
Day
SettlementBasis Daily mark to market settlement will be on a T+1 basis and final settlement will be cash settled on T+2 basis.
Modeof Settlement Cash settled in INR
Daily Settlement
Price
Final Settlement
Price
The final settlement price of the cross-currency derivatives contracts shall be computed using the FBIL
reference rate for USDINR and the corresponding exchange rate published by FBIL for EURINR, GBPINR and
JPYINR, as applicable, on the last trading day of the contract. For arriving at the final settlement value in INR
for EURUSD and GBPUSD contracts, the reference rate for USDINR on the last trading day of the contract
shall be used. For USDJPY contracts, the final settlement value in INR shall be arrived at using the exchange
rate published for JPYINR on the last trading day of the contract.

Contract Specification for Weekly Options on USDINR
Contract specification: Weekly Options Contracts on USDINR Currency Pair
Contract Size USD 1000
Quotation The contract would be quoted in Rupee terms (i.e., as INR Rupee per US Dollar), quoted upto the fourth
decimal place.
Contract trading
cycle
11 weekly expiry contracts excluding the expiry week of monthly contract. New serial weekly futures contract
shall be introduced after expiry of the respective week’s contract.
Expiry day)
Every Friday of the week except for expiry week of monthly contract (during the expiry week of monthly
contract, the contract will expire on day of expiry of monthly contract). In case the Friday is a trading holiday,
the previous trading day shall be the expiry/last trading day.
Daily Settlement
Price
Final Settlement
Price
FBIL reference rate on the date of the expiry of the contact

Type of orders
72
 The orders can be classified as per various parameters such as:
⚫ Time conditions; Price conditions and Other conditions
⚫ Time condition
⚫ Day order: It is an order which is valid for the day on which it is entered. If the
order is not executed during the day, the system cancels the order
automatically at the end of the day.
⚫ Immediate or Cancel (IOC): An IOC order allows the user to buy or sell a
contract as soon as the order is released into the system, failing which the
order is cancelled from the system. Partial match is possible for the order, and
the unmatched portion of the order is cancelled immediately.

Type of orders
73
⚫ Price conditions
⚫ Market price: Market orders are orders for which no price is specified at the
time the order is entered (i.e. price is market price). For such orders, the
trading system determines the price.
⚫ Limit price: An order to buy a specified quantity at or below a specified price
or an order to sell it at or above a specified price is called as limit price. This
order type ensures that a person will never pay for the futures contract more
than whatever price is set as the limit.
⚫ Stop-loss: This order type allows user to release an order into the system,
after the market price of the security reaches or crosses a threshold price.
Ex: If for stop-loss buy order, the trigger is Rs. 64.0025 and the limit price is
Rs. 64.2575 , then this order is released into the system once the market price
reaches or exceeds Rs. 64.0025. Similarly, if for a stop-loss sell order, the
trigger is 64.2575 and the limit price is 64.0025. This stop loss sell order is
released into the system once the market price reaches or drops below
64.2575.
⚫ Thus, for the stop loss buy order, the trigger price has to be less than the limit price and
for the stop-loss sell order, the trigger price has to be greater than the limit price.

Example -Stop loss order and limit order
74
⚫ Assume you are holding a short USDINR currency future position at 65. You
are concerned about increasing losses with likelihood of INR depreciation.
You want to square off the short position if the price rises above 65.20 and
limit your losses. In such a case, you would place a stop loss buy order with
trigger price as 65.20
⚫ Similarly, assume that you are of the view that INR to appreciate but your
view would get confirmed if futures trades below 64.80. You want to initiate
a short position as soon as the contract breaches 64.80 on the down side. In
this scenario, you would place a stop loss sell order with trigger price as
64.80

Type of orders- other conditions
75
 TM has to identify whether each order is of client’s order or his own order
(Proprietary trading)
 Pro: Pro means that the orders are entered on the trading member's own
account
⚫ Cli: Cli means that the trading member enters the orders on behalf of a client

Clearing and settlement
76
 Clearing means computing open positions and obligations of clearing
members in the trading system. Whereas,
 Settlement means actual pay in or pay out to settle the contract. The open
positions computation is used to arrive at daily mark to margin requirement
and maintaining exposure norms. The settlement could be of mark to market
settlement which happens on daily basis or could be final settlement which
happens at the expiry of the contract
 Clearing Corporation undertakes clearing and settlement of all trades
executed on the currency derivatives segment of the exchange. It also acts as
legal counterparty to all trades on the currency derivatives segment and
guarantees their financial settlement

Clearing and settlement entities
77
 In addition to clearing corporation, the entities involved in clearing and
settlement are as follows:
 Trading cum clearing member: A member with a right to trade on its own account
as well as on account of its clients. He can clear and settle the trades for self and
for others through the Clearing House
 Professional clearing member (PCM): A professional clearing member is a clearing
member who is not a trading member. Typically, banks & custodians become PCM
and clear and settle for their trading members and participants
 Clearing bank: Funds settlement takes place through clearing banks. For the
purpose of settlement all clearing members are required to open a separate bank
account with the clearing corporation designated clearing bank for currency
derivatives segment. The clearing and settlement process comprises of the
following three main activities:
⚫ Clearing
⚫ Settlement
⚫ Risk management

Clearing: computing open position
78
 Computing open positions of CMs: By aggregating the open positions of all
the TMs and all custodial participants clearing through him
 Computing open positions of TMs: By aggregating his proprietary open
position and clients' open positions. Proprietary positions are calculated on
net basis (buy - sell) for each contract. Clients' positions are arrived at by
summing together net (buy - sell) positions of each individual client.
Therefore for TM, open position is the sum of proprietary open position,
clients’ open net long position and clients’ open net short position.

Computing open position of TM
79
 Let us take an example to understand computing open position:
 A trading member XYZ trades for his own proprietary account and has three
clients A, B and C trading through him. The day wise trading activity of XYZ’s
proprietary deals and trading activity of his clients are given below
* All of same contract and not across different contracts
 As mentioned earlier, the long and short deals are netted off for proprietary
deals and also for deals of individual clients to compute open position for
each client and proprietary book. Using this principle, the open position at
the end of day is given below
XYZ’s proprietary
deals*
A’s deals* B’s deals* C’s deals*
Day 1 Buys 40, sells 60 Buys 20, sells
10
Buys 30, sells
10
Buys 10, sells
20
Day 2 Buys 40, sells 30 Buys 10, sells
30
Buys 20, sells
10
Short 20

80
 Please note that in the example, the deals were done the in the same
contract and not across different contracts
 While computing open position at the TM/CM level, the direction of trade
(long vs. short) has no relevance.
XYZ’s proprietary
deals
A’s deals B’s deals C’s deals
For trades done on Day 1 Short 20 Long 10 Long 20 Short 10
Carry forward to Day 2 Short 20 Long 10 Long 20 Short 10
For trades done on Day 2 Long 10 Short 20 Long 10 Short 20
At the end of Day 2 Short 10 Short 10 Long 30 Short30

81
 Now let us compute open position for XYZ. As a Trading member, open position
would be a combination of open position of XYZ as a proprietary client and that
for each of the three individual clients
** 60 units = 20(Prop book)+10 (A’s open position)+20 (B’s open positions)+10 (C’s open position)
*** 80 units = 10(Prop book)+10 (A’s open position)+30 (B’s open positions)+30 (C’s open position)
⚫ All open position would be multiplied by 1000 for USD, EUR, GBP and by 100,000
for JPYINR deals. This is because of the contract size specifications.
⚫ The open position for XYZ was 60,000 USD (60 x 1000) at the end of day 1 and
was 80,000 USD (80 x 1000) at the end of day 2.
Open
position of
XYZ as TM
Open position of
XYZ’s
proprietary book
Open
position
of A
Open
position
of B
Open
position
of C
End - Day
1
60 units** 20 units 10 units 20 units 10 units
End - Day
2
80 units*** 10 units 10 units 30 units 30 units

Settlement of currency options
82
⚫ Settlement of premium: Premium would be paid in by the buyer in cash and
paid out to the seller in cash on T+1 day. Until the buyer pays in the
premium, the premium due shall be deducted from the available Liquid Net
Worth on a real time basis
⚫ Settlement on expiry: On expiry date, all open long ITM contracts, on a
particular strike of a series, at the close of trading hours would be
automatically exercised at the final settlement price and assigned on a
random basis to the open short positions of the same strike and series

Risk management – currency options
83
⚫ Initial margin: The Initial Margin requirement would be based on a worst
case scenario loss of a portfolio of an individual client comprising his
positions in options and futures contracts on the same underlying across
different maturities, across various scenarios of price and volatility changes
⚫ Extreme loss margin would be deducted from the liquid assets of the
clearing member on an online, real time basis. Extreme loss margin is
computed as percentage of the mark-to-market value of the Gross Open
Position.
⚫ Net Option Value is the current market value of the option times the
number of options (positive for long options and negative for short options)
in the portfolio. The Net Option Value would be added to the Liquid Net
Worth of the clearing member. This means that the current market value of
short options is deducted from the liquid net worth and the market value of
long options is added thereto

Risk management- currency options
84
⚫ Calendar spread margin: A long currency option position at one maturity
and a short option position at a different maturity in the same series, both
having the same strike price would be treated as a calendar spread. The
margin for options calendar spread would be the same as specified for
USDINR currency futures calendar spread

Settlement of currency futures
85
 Currency futures are cash settled.
 Mark to market settlement
 Final settlement
 Mark to market settlement could be for three type of transactions:
⚫ Squared off position: The buy price and the sell price for contracts
executed during the day and squared off.
⚫ Positions not squared off: The trade price and the day's settlement price
for contracts executed during the day but not squared off.
⚫ Brought forward positions: The previous day's settlement price and the
current day's settlement price for brought forward contracts.

Example 1: TM’s own deals and its client deals in same
86
contract
⚫ A TM has proprietary deals and deals of his two clients who trade only in
USDINR contracts of same maturity. Trading details given below:
XYZ’s proprietary deals A’s deals B’s deals
Day 1 Buys 40 @ Rs 65, sells
60 @ Rs 65.20
Buys 20 @ Rs 65.15,
sells 10 @ Rs 65.05
Buys 30 @ Rs 65.10, sells
10 @ Rs 65.20
Day 2 Buys 40 @ Rs 65.40,
sells 30 @ Rs 65.30
Buys 10 @ Rs 65.30,
sells 30 @ Rs 65.40
Buys 20 @ Rs 65.20, sells
10 @ Rs 65.10

87
contract
⚫ Assume, daily settlement price as 65.15 (day 1) and as 65.30 (day 2). The
profit/ loss for mark to market purpose at the end of day 1 is shown below
XYZ’s proprietary
deals
A’s deals B’s deals
For squared off
positions
40 x 1000 x 0.2 =
8000
10 x 1000 x
(0.10) =
(1000)
10 x 1000 x 0.1 =
1000
For positions not
squared off
20 x 1000 x 0.05
=1000
10 x 1000 x 0 = 0 20 x 1000 x 0.05 =
1000
For positions
brought forward
None None None
Total 9000 (1000) 2000

88
contract
⚫ At the end of day 2, the profit/ loss for mark to market purpose:
⚫ In above example, there was no MTM netting off done across clients
XYZ’s proprietary
deals
For squared off
positions
30 x 1000 x (0.1) =
(3000)
10 x 1000 x
0.10
= 1000
10 x 1000 x (0.1)
=
(1000)
For positions not
squared off
10 x 1000 x (0.1)
=(1000)
20 x 1000 x 0.1
=
2000
10x 1000 x 0.1 =
1000
For positions
brought forward*
20 x 1000 x (0.15) =
(3000)
10 x 1000 x
0.15
= 1500
20 x 1000 x 0.15
=
3000
Total (7000) 4500 3000

89
currency pair but across maturities
 The trading details are given below. The daily settlement price at the end of day 1
for July contract was 65.15, for Aug contract was 65.45 and at the end of day 2,
the daily settlement price for July was 65.05 and for Aug was 65.30
XYZ’s proprietary
deals
Day 1 Buys July 40 @ Rs
65, sells Aug 60 @
Rs 65.20
Buys July 20 @ Rs
65.15, sells July 10
@ Rs 65.05
Buys Aug 30 @ Rs
@ Rs 65.15
Day 2 Buys Aug 60 @ Rs
@ Rs 65.30
Sells July 10 @ Rs
65.25
Buys July 10 @ Rs
65.05, sells Aug 10
@ Rs 65.40

Example 2: TM’s own deals and its client deals in different
90
contracts of same currency pair or different pair
 When contracts are for different maturity or for different currency pair, each
contract is taken as a separate contract and there is no netting off done
across contracts, both for each client and also across clients
 At the end of day 1 MTM is shown below:
XYZ’s proprietary deals A’s deals B’s deals
For squared
off positions
None (as buy and sell we r e
in t w o different contracts)
10 x 1000 x (0.10)
= (1000)
None
For positions
not squared
off
July: 40 x1000 x 0.15=
6000
Aug: 60 x1000 x (0.25) =
(15000)
10 x 1000 x 0 = 0 July: 10 x1000 x 0=
0
Aug: 30x1000x0.1
= 3000
For positions
brought
forward
None None None
Total 6000, (15000)* (1000) 3000

Final settlement on contract expiry
91
 On the last trading day of the futures contracts, after the close of trading
hours, the Clearing Corporation marks all positions of a CM to the final
settlement price and the resulting profit/loss is settled in cash
 Final settlement loss/profit amount is debited/ credited to the relevant CM's
clearing bank account on T+2 working day of the contract expiry day
 The final settlement price is the FBIL reference rate for the last trading day of
the futures contract

Risk management
92
 Since futures is a leveraged position, a strong risk management is critical for
successful working on futures market
 Effective margining framework at exchange is key to avoid any systemic
failure during periods of high volatility
 Margins play the role of acting as a deterrent to excessive speculation and
forces participants to constantly review their positions
 The actual position monitoring and margining is carried out on-line through
exchanges’ Risk Management Systems that use SPAN® (Standard Portfolio
Analysis of Risk) methodology, and compute on-line margins, based on the
parameters defined by SEBI

Regulations - SCRA
93
⚫ Securities Contracts (Regulation) Act, 1956 [SC(R)A]
⚫ SCRA is the principle act which governs trading of securities in India. SC(R)A
aims at preventing undesirable transactions in securities, by regulating the
business of dealing therein and by providing for certain other matters
connected therewith
⚫ It defines meaning of securities and derivatives

Regulations – Joint committee of SEBI and RBI
94
⚫ In a joint meeting of RBI and SEBI on 28th February 2008, it was decided to
constitute a RBI-SEBI Standing Technical Committee on Exchange Traded
Currency and Interest Rate Derivatives. The Committee would evolve norms
and oversee the implementation of Exchange traded currency futures
⚫ The committee submitted its report on 29th May 2008 and it was called as
The Report of the RBI-SEBI Standing Technical Committee on Exchange
Traded Currency Futures
⚫ The recommendation of this committee was the basis for launching
currency futures and its associated design, rules and regulations

Regulations - FEMA
95
⚫ Foreign exchange management act, 1999 (FEMA)
⚫ It is the primary act governing dealing in foreign exchange in India. RBI is the
supervisory body to implement provisions of FEMA
⚫ RBI made amendment to provisions of FEMA, 1999 to facilitate trading in
currency futures. These amendments were released on 6th August 2008 via
RBI Notification No. FED.1/DG(SG)-2008. The directions issued under this
notification are titled “Currency Futures (Reserve Bank) Directions, 2008”
came into force w.e.f. 6th August, 2008. The salient features of this
notification are:
⚫ The Scheduled Banks have to obtain permission from the respective
Regulatory Departments of RBI to participate in Currency Futures Markets.

Regulations- FEMA
96
⚫ Other regulated entities have to obtain concurrence from their respective
regulators for participation in Currency Derivatives Markets
⚫ The membership of the currency derivatives market of a recognised stock
exchange shall be separate from the membership of the equity derivative
segment or the cash segment
⚫ Banks authorized by the RBI under section 10 of the Foreign Exchange
Management Act, 1999 as ‘AD Category - I bank’ are permitted to become
trading and clearing members of the currency futures segment of the
recognized stock exchanges, on their own account and on behalf of their
clients, subject to fulfilling the following minimum prudential requirements:
⚫ Minimum net worth of Rs. 500 crores.
⚫ Minimum Capital adequacy ratio (CAR) of 10 per cent.
⚫ Net NPA should not exceed 3 per cent.
⚫ Made net profit for last 3 years.

Code of conduct for brokers
97
⚫ General code of conduct
⚫ Integrity
⚫ Exercise of due skill and care
⚫ No manipulation and malpractice
⚫ Compliance with statutory requirements
⚫ Duty to the client
⚫ Execution of orders and issuance of contract notes
⚫ Breach of trust
⚫ Business and commission
⚫ Business with defaulting clients
⚫ Fairness to clients
⚫ Investment advice in publicly accessible media

Code of conduct for brokers
98
⚫ Brokers vis-a-vis other brokers
⚫ Protection of client interest
⚫ Transactions with other brokers
⚫ Advertisement and publicity
⚫ Inducement to clients
⚫ False or misleading returns

Code of conduct specific to currency derivatives
99
⚫ General principles and guidelines
⚫ A TM shall make adequate disclosures of relevant material information in his
dealings with his clients.
⚫ No TM or person associated with the TM shall guarantee a client against a loss
⚫ Professionalism: A TM in the conduct of his business shall observe high standards
of commercial honor of just and equitable principles of trade.
⚫ Adherence to Trading Practices: TM shall adhere to all the relevant rules,
regulations and bye-laws
⚫ Honesty and Fairness: In conducting his business activities, a TM shall act
honestly and fairly, in the best interests of his constituents
⚫ Capabilities: TM shall employ effectively the resources and procedures which are
needed for the proper performance of his business activities
⚫ Shielding or assisting
⚫ Suspended derivative contracts
⚫ Misleading transactions
⚫ Use of information obtained in fiduciary capacity

100
⚫ Trading principles - TM shall ensure:
⚫ Fiduciary and other obligations complied with
⚫ Employees are adequately trained in operating in the relevant market
segment in which they deal and are aware rules and regulations
⚫ A TM shall be responsible for all the actions including trades originating
through or with the use of all following variables - Trading Member Id and
User Id, at that point of time
⚫ No TM or person associated with a Trading Member shall make improper use
of constituent’s securities/positions in derivatives contracts or funds
⚫ Abide by regulations governing advertisement and publicity
⚫ No TM shall exercise any discretionary power in a constituent’s account
unless such constituent has given prior written authorization to a stated
individual or individuals and the account has been accepted by the Trading
Member, as evidenced in writing by the Trading Member

101
⚫ Trading principles - TM shall ensure: (continued)
⚫ A TM shall not act as a principal or enter into any agreement or arrangement
with a constituent or constituent’s agents, employees or any other person
connected to the constituent, employee or agency, whereby special or
unusual rates are given with an intent to give special or unusual advantage to
such constituent for the purpose of securing his business
⚫ The TM shall not disclose the name and beneficial identity of a constituent to
any person except to the Currency Derivatives Segment of the Exchanges as
and when required by it
⚫ The facility of placing orders on ‘Pro-account’ through trading terminals shall
be availed by the TM only at one location of the Trading Members as
specified / required by the Trading Members

Grievance redressal mechanism of exchange
102
⚫ Each exchange has dedicated department for investor complaint redressal
⚫ Investor service committee (ISC) oversees functioning of this department
⚫ Process for complaint redressal
⚫ Receipt of complaint
⚫ Redressal of complaint
⚫ Investors can also register their complaints using “SEBI Complaints Redress
System (SCORES)”

SCORES - SEBI Complaints Redress System
⚫ SEBI Complaints Redress System (SCORES) [www.scores.gov.in] is
a centralized web based complaint lodging and status monitoring
system accessible to investors from anywhere, 24x7.
⚫ Investors not familiar with computers can lodge complaints in
offline mode with SEBI. The complaint will be scanned and
uploaded to SCORES.
⚫ SCORES will expedite the complaint resolution system, as the
physical movement of files is done away with.
⚫ Complaints lodged on SCORES can be retrieved and tracked at
anytime.

SCORES - SEBI Complaints Redress System [… continued]
Procedure for filing and redressal of investor grievances using SCORES:
⚫ Investors who wish to lodge a complaint on SCORES have to register
themselves on www.scores.gov.in.
⚫ Upon successful registration, a unique user id and a password will be
communicated to the investor through an acknowledgement email/SMS.
⚫ Using the login credentials, the investor can lodge his/her complaint on
SCORES.
⚫ The complainant may use SCORES to submit the grievance directly to
companies/intermediaries and the complaint shall be forwarded to the
entity for resolution.
⚫ The entity is required to redress the grievance within 30 days, failing
which the complaint shall be registered in SCORES.

Nature of complaints to be taken up by exchange
105
⚫ Kind of complaints that exchanges take up:
⚫ Complaints against TM on account of delay or non-receipt of funds /
securities, documents, unauthorised trades, excess brokerage, unauthorised
transfer of funds from one account to another
⚫ Complaints against listed companies such as non-receipt of corporate
benefits (dividends, interest, bonus shares, stock split, etc), non-receipt of
securities after dematerialization, after transfer / transmission, non-receipt of
allotment advice, securities allotted, refund order, etc.

Nature of complaints that may not be taken up by exchange
106
⚫ Kind of complaints that exchanges may not take up:
⚫ In respect of transactions which are already subject matter of Arbitration
proceedings,
⚫ Involving payment of funds, transfer of securities to entities other than TM
⚫ Claims for mental agony/harassment and expenses incurred for pursuing the
matter with the ISC,
⚫ Claims for notional loss, opportunity loss for the disputed period or trade,
⚫ Complaints pertaining to trades not executed on the exchange by the
complainant,
⚫ Claims of authorized persons for private commercial dealings with the trading
member,
⚫ Claims relating to transactions which are in the nature of loan or financing
which are not within the framework defined by the Exchange

Arbitration
107
⚫ Arbitration is a quasi judicial process of settlement of disputes between
Trading Members, Investors, Clearing Members and also between Investors
and Issuers (Listed Companies). Generally the application for arbitration has
to be filed at the Arbitration Centers established by the exchanges.
⚫ Parties can chose arbitrator from a panel of arbitrators provided by the
Exchange.
⚫ Arbitrator conducts the arbitration and passes the award normally within a
period of 4 months from the date of initial hearing.
⚫ The arbitration award is binding on both the parties. However, the
aggrieved party, within 30 days of the receipt of the award from the
arbitrator, can file an appeal to the arbitration tribunal for re-hearing.
⚫ Any party who is dissatisfied with the Appellate Bench Award may challenge
the same only in a Court of Law

Evaluation
108
Session 5

Information
110
⚫For moredetails, pleasevisit: www.nism.ac.in
⚫For queries: cpe@nism.ac.in
⚫Board Numbers (NISM): 8080806476

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