Home / Markets / Stock Markets /  Rupee volatility drives currency volumes on NSE to an all-time high

MUMBAI : Investors ranging from banks to institutions to day traders have sent currency derivatives trading volume on the National Stock Exchange to a record high in September as the rupee suffered its worst monthly drop against the dollar in 36 months against the backdrop of the US Federal Reserve’s resolve to hike rates aggressively to tamp inflation.

The average daily turnover of currency derivatives—both futures and options—on the country’s largest exchange clocked a record 1.64 trillion in September as the rupee weakened 3% to 81.86 a dollar, its sharpest monthly decline since March 2020, when the currency slid 4.85%.

The recent volatility in the rupee contributed to raising the average daily turnover of currency derivatives by 47% to a record high of 1.29 trillion in the six months to 28 September from 87,495 crore in FY22. The rupee has depreciated 8% against the dollar in the fiscal year to date.

“The multi-year volatility has attracted greater hedging and speculative activity on NSE’s rupee settled contracts," said Anindya Banerjee, vice-president (currency and interest rate derivatives), Kotak Securities. “Almost all participants have raised their currency trading activity, given the steep depreciation of the INR this month, in particular, and in the fiscal year so far."

NSE data shows that proprietary traders account for the bulk of the market share in percentage terms, followed by individual investors, FPIs, corporates and banks.

“Constituents like corporates who need dollars to make and receive payments use the OTC (over-the-counter) market that’s dominated by banks, with some residual risk being hedged on the NSE, which offers rupee settled contracts only," said Madan Sabnavis, chief economist, Bank of Baroda. “If rupee volatility rises, there is a jump in exchange volumes, which is what we’ve witnessed this month and year."

Exchange-traded currency derivatives offer an additional hedging mechanism to constituents like corporates, foreign portfolio investors (FPIs) and banks who normally deal in the OTC forex market, which facilitates buying and selling of currencies, like the dollar or pound sterling against the rupee, through a network of banks. For individual investors and prop traders who trade across asset classes like shares and commodities, they offer a means to speculate by taking on the risk that hedgers (FPIs, banks and corporates) seek to cover themselves against.

All contracts are settled in rupees, with the NSE segment offering futures and options on pairs such as USD-INR, GBP-INR, euro-INR and yen-INR. Since all contracts are cash settled (in rupee), comparison with the decentralized and larger OTC forex market where actual delivery happens is impractical.

Kotak’s Banerjee said dollar-rupee futures have an 85% share in total futures traded volume, while in options, the dollar-rupee pair accounts for over 95% share.

“The higher volatility has attracted all forex market participants to hedge with pro and retail normally being the counterparties," said Kishore Narne, director and head of currencies and commodities at Motilal Oswal Financial Services.

A currency futures contract facilitates the purchase or sale of a currency in exchange for another at a fixed price for delivery on a future date. A currency option similarly allows the purchase or sale of one currency in exchange for another when the option buyer makes payment to an option seller. On NSE, settlements of the currency contracts happen in rupee.

Say a corporate expecting a dollar remittance by September end hedges itself by selling dollar futures at 80 (ask) on the exchange to cover itself against a fall in the dollar or a rise in the rupee by the month end.

An FPI who invested in the Indian share market when the dollar was 80 and wishes to protect his potential dollar returns buys (bid) the dollar at 80.

The exchange’s order matching engine matches their sell and buy orders.

If the dollar rises to 81 at expiry, the corporate makes a loss of 1,000 per contract (lot size is $1,000) on the exchange while the FPI gains 1,000 per lot. The corporate mitigates the loss on futures by selling the actual dollar it receives in the OTC market at 81.

When the FPI books profit on shares and sells rupees it gets fewer dollars at the time of repatriation . But this loss is offset by the gain on the exchange .

Currency futures contracts expire two working days before the last business day of every month.

Options contracts have weekly expiration on Friday of the expiry week.

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