May 21 2018

USDINR Ideas – Vanilla Options have finally arrived – 21May2018

Despite being technically oversold for an extended period of time, the Indian Rupee continues to plummet against the dollar. Trading around the 68.10 mark, it is at its lowest level since Jan2017 – just about a percent away from its all-time low of 68.86. What has lead to rupee weakening is common knowledge. What is surprising is the pace of weakness (or volatility) – 5% plunge in 6 weeks. One of the best performing currencies in 2017 to one of the worst performing currencies in 2018 – that’s the tale of the Indian Rupee.

 

Let’s analyse certain facts:

  1. Rupee’s all-time low (around 68.79-86) was attempted thrice before – twice in 2016 and once in 2013. As such, it will take some task to break that critical resistance.
  2. The primary drivers for rupee weakness – surging crude prices and rising US bond yields (consequently rising dollar index) – may not continue for an extended period of time. My sense is that US bond yields may continue to rise a bit, but crude prices could certainly cool off. With Brent around 79, talks about US Shale Gas is surprisingly quiet.
  3. Rising crude and weakening rupee will stoke up inflationary pressures – government will try its best to prevent any such flare up – no wonder such extensive indications of reducing taxes on domestic fuel.
  4. FII outflows persist – more from debt than equity. Outflows from emerging markets will continue as long as US bond yields rise. This could pressurize the rupee.
  5. Rupee started weakening in isolation – recently, all its emerging market peers have started weakening too. Broad based emerging currencies’ decline.
  6. All markets analysts have revised their 3-6 month USDINR forecasts to 69-70. Remember, most of these forecasts were 61-62 just about 2 months back. I recall the old adage “when everyone prepares for an uptrend, the reverse happens.”

 

In such extreme uncertain times, making a prudent hedging decision is a huge challenge. One cannot hedge and one cannot remain unhedged. Vanilla options are the only solution.

 

I had recommended using vanilla options as a preferably hedging instrument in my research article dated 20 April 2018. Let’s analyse:

 

FOR IMPORTER   FOR EXPORTER  
Option Deal Date 23-Apr-18 Option Deal Date 23-Apr-18
USDINR Spot 66.3500 USDINR Spot 66.3400
Maturity 1 month Maturity 1 month
Maturity date 23-May-18 Maturity date 23-May-18
USDINR Forward rate 66.5800 USDINR Forward rate 66.5600
Option strike price 66.5800 Option strike price 66.5600
Option premium 0.4350 Option premium 0.4350
Spot on maturity date 68.1000 Spot on maturity date 68.1000
Scenario for importer Option exercised Scenario for importer Option not exercised
Net Rate for importer 67.0150 Net Rate for exporter 67.6650
Gain on option over market 1.0850 Gain on option over forward 1.1050

All pricing done on 23 April 2018 (next working day after my recommendation).

 

Vanilla options clearly works out better than no hedge (for importers) and forwards (for exporters).