What is Currency Derivatives?

Currency derivatives are popularly known as one of the best options if you wish to contain the volatility risk that foreign currency exchange rate has. In this article, we are going to look at currency derivatives meaning and how you can trade in it.

What is currency derivatives?

Currency derivatives are nothing but futures that are exchange-based and options contracts that let one protect oneself against the fluctuations in currency. Currency Derivative Trading has a lot of similarities with Stock Options and Futures trading. The assets being traded in this case are not stocks, but currency pairs. A currency future contract can be used to exchange one currency with another. This exchange can be made at a future date and at a price agreed upon on the day the contract is purchased. The Foreign Exchange Markets are where trading in Currency Options and Currency Futures is carried out. The Forex Rates are nothing but the value a foreign currency has concerning domestic currency. The major participants in India are various banks, exporters, importers and corporations.

In India, you can use currency derivatives to shield yourself against fluctuations in currencies like euro, pound, dollar and yen. Corporate sectors often use these contracts for specific currencies if they are subjected to imports and exports repeatedly.

In general, all such contracts are settled by cash in rupees. However, the Securities and Exchange Board of India recently agreed to begin cross currency contracts. So now, you have the option for contracts on euro-dollar, dollar-yen and pound-dollar too.

How can you trade in currency derivatives?

At the national level, the two stock exchanges BSE and NSE have segments for currency derivatives. A similar section is also available in the Metropolitan Stock Exchange of India, but the volumes are substantially lower than that of BSE and NSE. You can choose to take the assistance of brokers to trade in currency derivatives. In general, all leading stockbroker companies offer services for currency trading as well.

Trading in currency derivatives is quite similar to trading in equity and its derivatives. It can be done using the broker’s trading app. The contract size of a dollar-rupee contract is $1,000, but, to trade in it, you just need to pay a 2-3% margin.

Why was the currency derivative introduced on exchange platforms?

Before currency derivatives were introduced in exchanges, the only option people had was the over the counter market if they wanted to secure themselves against currency volatility. This is where contracts were negotiated and agreed upon.

This market was a closed one and was mostly used by financial institutions and banks for trade. The currency derivatives segment we have now, which is exchange-based, is a transparent market that is regulated. This is accessible to small businesses and individuals who wish to minimize their currency risks.

What are the uses of currency derivatives?

Currency derivatives are useful in the following ways-

Hedging: You can now protect yourself against foreign exchange exposures and curtail your losses by using currency derivatives. This will help you take appropriate positions by using hedging.

Trading: Currency options and futures let you trade by making use of the short-term movements in the market by keeping an eye on the direction of the movement.

Arbitrage:  Different markets and exchanges let you take advantage of the currency exchange rates through currency derivatives trading.

Leverage:  You do not need to pay the full traded value, but only a small margin value in currency futures and options trading.