Jan 28 2019

USDINR Ideas – Time to evaluate vanilla options

After witnessing increasing volatility in the last 5 months (from mid August 2018 to be precise), we see a period of relative tranquillity in the Indian Rupee for the past two weeks. Good news and bad news too. A period of serenity in the USDINR prices is good because it enables us to review our existing systems (and decisions) and focus on advancement. Bad news because it often makes risk managers procrastinate their hedging decisions (assuming that such tranquil times will continue) – this is something we need to be careful about.

Anyways, in such times, whenever the spot volatility is low – evaluating various vanilla options is a good idea. Lower spot volatility implying lower option premium is common knowledge. Since a risk manager’s primary objective is to hedge at minimum cost, considering vanilla options when option premiums are low (at times of low volatility) makes sense.

Consider the table below:

Trade Date 28-Jan-19 28-Dec-18 28-Jan-19 28-Dec-18
Maturity 1 month 1 month 3 month 3 month
USDINR Volatility 7.22% 8.30% 7.43% 8.51%
SPOT 71.1000 69.9825 71.1000 69.9825
FORWARD RATE 71.3250 70.2375 71.8450 70.6775
STRIKE PRICE 71.3250 70.2375 71.8450 70.6775
OPTION PREMIUM 59 Paise 67 Paise 104 Paise 118 Paise

A 1-month USDINR at-the-money (ATM) option, meaning option strike price = forward rate, has a premium cost of 59 paise today. A similar option taken a month back (on 28-Dec-2018) would have cost 67 paise – indicating that the option premium cost is 12% lower today, than it was a month ago. Similarly, a 3-month USDINR at-the-money option, has an option premium cost of 104 paise today compared to 118 paise if it was taken a month back – comparably 12% cheaper today.

Exporters and Importers: do vanilla options – am sure no one expects periods of low volatility to remain forever (or even prolong). There are multiple international factors (worries that the US Government may shut down again, BREXIT uncertainty, US-China trade war, etc) and domestic factors (Union budget, general elections, etc) which could send the currency into a tailspin. During such times, it is prudent to hedge using vanilla options and remain risk free.