Is The Margin In Currency Future Equivalent To Leveraging?

Is The Margin In Currency Future Equivalent To Leveraging?

07 Feb 2020 03:19 PM

Trading in the currency market which started in India in August 2008 has picked pace and over the last 12 years has seen an average daily turnover in currency futures and currency options increase from Rs 1,167 crores in 2008-09 to more than Rs 38,000 crores till now in 2019-20. This substantial increase in volume is not the actual money present in the system for trading but with the availability of margin money, the volumes have risen exponentially.

What is margin in derivatives market?

Derivatives market enables access to financial assets for trading at a future date and not just at the market trading date. In currency derivatives the trader agrees to buy or sell a fixed amount of a specified currency at the end or expiry of the pre-determined period. The underlying asset is a currency cross pair like the USD/INR, EUR/INR, GBP/INR or JPY/INR. These contracts are settled without the actual delivery of currency on expiry and thus are cash settled.

Even though one doesn’t have that volume of money for buying bigger lots of currency, one is able to trade in higher volumes. So margin is basically a deposit done in good faith against which the futures contract is managed.  It shouldn’t mistake as down payments as in stock margins.

Margin rate for futures

The margin rates are determined by the futures exchanges and are designed to ensure that traders meet their financial obligations. For a typical futures contract, the margin rate varies from 3% to 12% of the total value of the contract. So the trader has to pay an initial margin at the margin rate while initiating a futures contract.

National Stock Exchange clearing collects an upfront initial margin for all open positions which is based on the margins computed by the NSE clearing SPAN (Standard Portfolio of ANalysis of risk) from the clearing members who in turn are required to collect the initial margin from the trading members and their respective clients. This initial margin is based on 99% VAR (Value At Risk) over a day or two time horizon. The VaR computation is as per SEBI recommendations from time to time.

The amount of leveraged position is high in currency futures as the margin is a small percentage of the total futures contract value. But when the market volatility goes higher, the margin rates also increase proportionately. Thus a small move may wipe off the initial margin which is deposited with the trading member.

Daily MTM

The currency futures markets calls for marking the open position to market on each trading day. With this the margin amount is adjusted to show the trader’s gain or less depending on the closing price of the currency futures. This marking to market provides a cushion to the trading member who is trading on behalf of the trader. The initial margin is thus adjusted depending on the profit or loss.

Ticket or Lot size

The volume of transactions tends to be higher when the ticket size is small. This helps even the retail investor apart from the biggies and corporates to participate in the currency futures. For USD, EUR and GBP, the lot size is 1000 each while for JPY it is JPY 1,00,000.

Advantages of trading in Currency Futures

Currency derivatives have proved to be a transparent and efficient way to manage currency risk which arises when one is exposed to foreign exchange market.

Volatility in the foreign exchange market is highest amongst the financial markets and one, especially a corporate should protect the forex exposure and hedge for any potential losses. The fluctuations in the forex markets gives opportunities to hedge the exposure by buying or selling the currency as the case may be an importer or an exporter so that the payout/payin is fixed for a later period.

If events are anticipated before hand, the traders tend to speculate in the currency market. Currency futures give an opportunity to leverage the trade by paying a percentage of the total value as the margin and if currency movement is anticipated right, it would pave way for higher profits even when the margin money is low. Though many a times, speculative trading also leads to huge losses wiping away more than the initial money allotted for trading. So one should strategize and take informed decisions while trading. Putting stop losses, not increasing margin more than initially allotted, etc are some such strategies.

Trade in futures with caution

So in currency trading, margin may be taken as a leveraged position but since it is marked to market (MTM) on a daily basis, the chances or faltering are low. Incase the trader is not able to provide the relevant adjusted margin then the trading member will reduce the position according to the funds in the initial margin. With the RBI progressively increasing the trading hours of currency in the foreign exchange market for authorized dealer bank, the volumes are only going to increase further, but are the supporting systems and companies showing the green light yet?

Appropriate advice from experienced forex experts has proved to be more beneficial than just speculating in the currency futures markets. Myforexeye has a combination of many services related to foreign exchange. Currency trading with guidance from forex experts and specific forex exposure advisory services are some of the services which help the trader to make informed trading calls while aiming to make profits through currency futures. Their state of the art dealing room helps in tracking the open trades and also smooth execution helps in achieving the desired profits. Thinking of forex, think of Myforexeye!

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