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It’s high time currency options are introduced

It’s high time currency options are introduced
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First Published: Mon, Jan 25 2010. 11 05 PM IST

Updated: Mon, Jan 25 2010. 11 05 PM IST
Within a few months of its launch, it was evident that trading in currency futures was successful. But Indian policymakers took 16 months before approving new products. Futures trading on three new pairs—euro-rupee, pound-rupee and yen-rupee—has now been approved. While this is welcome, one would have liked things to move faster in terms of new product introduction.
The new currency pairs will be useful for end-users such as companies that have those currency exposures. Needless to say, they would generate far less trading interest compared with the dollar-rupee contract. In that context, a product that would be an obvious hit would be options on the dollar-rupee. Not only do far more participants have a view on this currency pair, but market participants are also increasingly becoming comfortable using options contracts for trading and hedging.
In the equity derivatives market, options are clearly the rage. Last month, they accounted for 52% of total equity derivatives turnover on the National Stock Exchange. Two years ago, they formed just 11% of the market. Index options, which account for the majority of this, are now 2.3 times bigger compared with the index futures market. Two years ago, they were a just one-third the size of the index futures market.
Graphic: Ahmed Raza Khan / Mint
The growth of the market has been facilitated by the increased volatility after the financial crisis, but in the process Indian market participants have clearly grown in carrying out sophisticated trades using options. The steady growth of algorithmic trading will only spur the growth of options trading in the country. In this backdrop, it is high time currency options are introduced.
While Indian policymakers drag their feet on new product approval, overseas exchanges have introduced similar products. In March last year, the Nasdaq OMX Group Inc. listed options on the WisdomTree Dreyfus Currency Income ETF family, which includes an ETF (exchange-traded fund) on the Indian rupee. The WisdomTree Dreyfus Indian Rupee Fund essentially facilitates dollar carry trade, by seeking to achieve total returns reflective of both money market rates in India available to foreign investors and changes in value of the rupee relative to the US dollar.
Since the differential in money market rates is negligible, the return for the ETF investor is primarily dependent on the change in the currency rates. Options on this ETF, similarly, can largely be seen as a play on the currency. Volumes on the ETF are thin and there are days when it’s not traded at all, but that hasn’t stopped Nasdaq from launching options on the product.
This is a far cry from new product introduction in India, where policymakers decide everything about a product launch including product design. For all one knows, another committee may be set up to decide on the product design for currency options. Given the vast experience with equity options and dollar-rupee futures, actually it shouldn’t take long to launch currency options. But for some reason, the approval is still awaited.
Also, in order to effectively compete with currency ETFs and options on overseas exchanges, policymakers should open the market for foreign investor participation. While foreign institutional investor participation is allowed in the interest rate futures market and the equity derivatives market, they are still not given access to the currency market. Their entry will greatly enhance the depth of the market.
This column has argued in the past that new product introduction should be left to the exchanges. Of course, in products involving currencies, there may be notifications that may be required related to the Foreign Exchange Management Act. But for many other products, it’s a pity that exchanges have to wait for regulatory approval for every new launch.
By the time the product is approved, the competitive edge is lost and competing exchanges have ample time to mimic the product. As a result, Indian exchanges are left to compete with each other primarily on pricing. This can lead to unhealthy outcomes and the best way to tackle this is to give greater freedom with product innovation. In this regard, the Securities and Exchange Board of India did give some room to stock exchanges to decide on market timings within a certain range. But clearly, a lot more needs to be done.
In The Money runs every other Tuesday. Comments are welcome at inthemoney@livemint.com
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First Published: Mon, Jan 25 2010. 11 05 PM IST