Thursday, February 24, 2011

Rapid buildup of currency options open interest

Today, on NSE, derivatives trading showed the following numbers:

Product classTurnover (Billion rupees)
Index futures 353
Index options 1981
Stock futures 391
Stock options 48
Currency futures 178
Currency options 30
Total 2981

This is really something: Rs.2.98 trillion notional rupees in a day. It's starting to sound like a real market.

This data shows an incredible domination of Nifty futures and options. It also shows the massive success of Nifty options.

One element of the options to futures ratio with equities lies in the securities transactions tax, which has distorted the market in favour of options. In the case of currencies, this distortion is absent. Hence, the ratio of options to futures that we see there should reflect the undistorted applications of the products by the market.

Now that the NSE trading community has skills on options, the question arises: Do these skills readily port over into currency options? I believe they should: every good Nifty options trader is a good INRUSD options trader. The same options knowledge should pretty much carry over from equity stock or equity index options to currency options. In fact, with small modifications, the algorithmic trading that is being done on the equity options should readily deploy into the currency options.

So what does the evidence show? Currency options trading (INR/USD only, says the RBI) started on 29 October 2010. I have 117 trading days of data for the open interest of INRUSD options. Let's compare the rise of open interest starting from contract launch:

The early days of currency futures trading was hard work: the open interest got up to $0.2 billion and stopped growing. In contrast, open interest with currency options has grown very fast in these 117 days. At each contract expiration, it has been much bigger than the previous one.

As a consequence, INRUSD options open interest is now bigger than INRUSD futures open interest, even though the latter has been a market that has been around for much longer:

This is consistent with the story that the Nifty options brainpower would yield a rapid establishment of the currency options market. This also tells us that not all of the domination of equity options is a distortion caused by the differential securities transaction tax.

This rise of the options and futures open interest has done a great deal for the viability of enterprise-scale economic risk management using the currency futures and options, given that the position limit is linked to the overall open interest. The limit is now looking big enough to be of interest to even the biggest Indian companies.

Some older materials that you might like to see:

1 comment:

  1. Ajay,
    I agree with your point. But if both futures and options were started at the same point many would have preferred options than futures. But in India futures was started much earlier then we came with options. There's no surprise people are towards currency futures than options. As they say futures is like Hindu marriage and options is like American girlfriend.


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