Turmoil in India's exchange-traded FX options on forced position unwinding

Indian rupee‘s exchange-traded options went into a tizzy on Wednesday after brokers asked clients to submit proof of underlying exposure on their derivative contracts or unwind their existing positions, three market participants said.

This came after brokers thought a central bank rule, to be effective on April 5, that exchange-traded rupee derivative transactions can be used only for hedging meant brokers had to collect proof of such exposure before allowing such trades.

However, as Reuters exclusively reported, brokerages were doing so of their own volition and had not been instructed to do so by the central bank.

The premium on out-of-the-money dollar/rupee put options expiring on April 26 soared up to 250%, despite spot dollar/rupee inching up 0.04% to 83.4200.

Typically, the premium on put options should fall when spot prices rise, unless there is a change in volatility expectations.

Further, the option premium on the 83.25 strike put was higher than on the 83.3750 strike put. A put option allows the buyer to sell dollar/rupee at the strike price on the expiry date. A right to sell at a lower strike price should cost less.

“The liquidity in options is drying up, bid-ask prices are wider, leading to the anomalies (in premiums),” said Sajal Gupta, executive director and head of forex and commodities at Nuvama Institutional.

“It’s a very challenging situation out there.”

Out-of-the-money call options for the April 26 expiry climbed between 100% and 300%.

“This is unprecedented. The forced unwinding of positions is leading to full-on panic,” said a head at a large brokerage, declining to be named due to company orders to not speak to the media on any matter related to rupee currency derivatives.

“We had, in a way, anticipated this and yesterday itself we were asking our clients to exit their positions.”

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