Currency Chapter Notes

Chapter 5: Strategies using Exchange Traded Currency Derivatives

NISM Series I — Currency Derivatives | ~12% weightage | ~77 questions

What this chapter is about

This is where everything comes together — you use futures and options to hedge, speculate, and arbitrage across currency pairs. The exam loves scenario-based questions: "An exporter expects to receive USD — what should they do?" or "USDJPY is moving from 105 to 108 — which futures do you use in India?" Cross-currency views using Indian futures pairs is unique to Series I and heavily tested. Master the exporter/importer hedge logic and the cross-currency trade construction.

Exporter vs Importer strategies

Exporter (will RECEIVE foreign currency in future):

• Risk: foreign currency depreciates (USDINR falls = INR appreciates)
• Hedge: SELL USDINR futures OR BUY USDINR put options
• Logic: If USD weakens, futures profit offsets lower conversion rate

Importer (will PAY foreign currency in future):

• Risk: foreign currency appreciates (USDINR rises = INR depreciates)
• Hedge: BUY USDINR futures OR BUY USDINR call options
• Logic: If USD strengthens, futures profit offsets higher payment cost

Exchange traded preferred when: Multiple banks are quoting different prices and the company wants transparent, standardised pricing.

OTC preferred when: Need exact maturity match (e.g., 70-day exposure but exchange only has 30, 60, 90 day contracts — basis risk from mismatch).

Option strategy selection — the two-dimensional test

Every option strategy question gives you TWO inputs: market view + volatility view.

Rule: If you want maximum profit potential → BUY options. If you want zero cash outgo → SELL options (receive premium). The "zero cash outgo" constraint always eliminates buying.

Cross-currency views using Indian futures

India doesn't trade USDJPY or EURUSD directly as futures. But you can construct any cross-currency view using USDINR, EURINR, GBPINR, JPYINR combinations.

Logic:

Buy USDINR = long USD, short INR
Sell JPYINR = short JPY, short INR (wait — INR cancels)
Combined: long USD, short JPY = bullish USDJPY view

Reference table:

Example: EURUSD moving from 1.18 to 1.30 means EUR strengthening vs USD. → In India: Long EURINR (EUR up vs INR) + Short USDINR (USD down vs INR) = EUR up vs USD. ✓

Convergence trade — futures at premium to spot

When futures trade at a premium to spot AND you expect spot to remain unchanged at expiry:

• Action: SELL futures now at premium
• P&L: At expiry, futures = spot, profit = premium collected

Example: USDINR spot = 82, one-month futures = 82.50 (50p premium) View: spot stays at 82 at expiry Trade: Sell one-month futures at 82.50 At expiry: close at 82.00 → profit = 0.50 × 1,000 = Rs 500 per lot

Arbitrage between OTC and futures

When futures price ≠ OTC price for same maturity:

Futures overpriced vs OTC:

• Buy in OTC at ask price (cheaper)
• Sell in futures at bid price (expensive)
• Profit = futures bid − OTC ask

Example: OTC one-month USDINR: 86.60/86.75 Futures one-month USDINR: 87.10/87.20

Buy in OTC at 86.75 (ask), Sell in futures at 87.10 (bid) Profit = 87.10 − 86.75 = 0.35 per USD = 35 paise

Calendar spread strategies

When interest rate differential between countries changes, the spread between near and far month futures changes.

If India rates rise (or US rates fall): Interest rate differential widens → futures premium widens → far month futures becomes more expensive relative to near month. Trade: Sell far month (expensive) + Buy near month (cheap) = Short calendar spread

Example from exam: 3M at 60.20, 6M at 61.10 (current spread = 0.90) Expected: 3M at 59.90, 6M at 60.50 (expected spread = 0.60) Spread narrows → profitable to: Buy 3M + Sell 6M P&L = (0.90 − 0.60) × 1,000 = Rs 300 profit per lot

Gold investment hedge

Indian investor buys gold in INR. Gold prices are determined by:

1. USD/GOLD (international gold price)
2. USDINR exchange rate

To hedge currency risk on gold investment: Sell USDINR futures (short USDINR) If USD weakens (USDINR falls), gold profit in USD terms gets compressed in INR → futures profit offsets.

Real returns on overseas investment with hedging

Example: Mrs. Soni invests Rs 1,00,000 in Indian bond at 9% for 1 year. Wants to convert proceeds to USD for daughter's education abroad. Spot USDINR = 73, one-year premium = 5%.

After one year: Rs 1,00,000 × 1.09 = Rs 1,09,000 IRP gives futures: 73 × 1.05 = Rs 76.65

USD she can send = 1,09,000 / 76.65 = 1,422 USD

Trap Alert

Trap 1: "Exporter should buy USDINR futures to hedge" — WRONG Exporter will receive USD — they want to lock in the SELLING rate for USD. Sell USDINR futures. (An importer who has to PAY USD should buy USDINR futures.)

Trap 2: "Zero cash outgo = buy options" — WRONG Buying options requires paying premium = cash outgo. Zero cash outgo = SELL options (receive premium instead).

Trap 3: "Long EURINR + Short USDINR = bullish INR" — WRONG INR exposure cancels out. This is a bullish EUR vs USD view (INR is the vehicle currency).

Trap 4: "Short straddle profits from high volatility" — FALSE Short straddle (sell both call and put) profits from LOW volatility / range-bound market. Long straddle profits from high volatility.

Must-remember rules

• Exporter (receives USD) → SELL USDINR futures / BUY put options
• Importer (pays USD) → BUY USDINR futures / BUY call options
• Zero cash outgo = sell options | Maximum profit potential = buy options
• Cross-currency: Long A + Short B uses INR as vehicle, expresses A vs B view
• USDJPY bullish: Long USDINR + Short JPYINR
• EURUSD bullish: Long EURINR + Short USDINR
• Convergence trade: futures at premium, sell futures, profit as they converge to spot
• Arbitrage: buy cheap (OTC), sell expensive (futures), profit = spread
• Calendar spread P&L = change in spread × lot size

Weightage note

~12% = ~77 questions. Mix of scenario-based (which strategy?) and numerical (how much profit?). Cross-currency construction appears in every exam 2-3 times. Exporter/importer scenarios appear 3-4 times. Calendar spread P&L appears 1-2 times. Arbitrage OTC vs futures appears 1-2 times.

Quick revision — 60 second scan

• Exporter: Sell USDINR futures OR Buy put
• Importer: Buy USDINR futures OR Buy call
• Zero outgo: Sell options | Max profit: Buy options
• Cross-currency: Long X-INR + Short Y-INR = long X vs Y
• Convergence: Sell futures at premium, profit as they converge to spot at expiry
• Arbitrage: buy OTC (ask), sell futures (bid), profit = difference
• Calendar spread: spread narrows = profit for buy near/sell far