Re Slide Leaves a Hole in Currency Traders’ Pockets

Broking houses, proprietary desks dealing in currency derivatives suffer as bets go awry The unexpected and steep decline of the rupee in September has caught many traders in the currency market on the wrong foot. These traders had placed bets that the rupee would not fall below 47 to 48 against the US dollar through futures and options contracts. But their forecasts went awry when the rupee slid to 50.  The repercussions of such blundered bets in the forex futures and options segment have been severe, resulting in closure of subsidiaries of many broking houses and proprietary desks dealing in currency derivatives. Clients of the five large retail broking houses had to cough up an aggregate . 600 crore for the losses, and the activity in this segment has dwindled.  The unanticipated dollar rush led by the flight of money from riskier assets, including emerging markets in September that drove down the rupee, tossed a spanner in the works for these traders. They had bought rupee futures at around 47 to 48 on the hopes that there would be a rebound after the rapid decline from around 45. "Many clients were forced to square off their positions at a loss because of the rupee's sharp fall to 50," said DK Aggarwal, chairman and MD, SMC Investments & Advisors, a subsidiary of SMC Global Securities.  Exposure to derivative trades such as futures is done by putting a margin or paying a premium for an option to buy an asset (call) or to sell one (put). Putting a margin or a premium allows a trader to lever himself by paying just a fraction of an asset value. Losses Mostly in Currency Futures  For instance, around 5% overnight margin on currency futures allows a person to lever himself 20 times. In stock futures, this margin can be between 15% and 20%.  While losses of retail traders were mostly in the currency futures segment, the savvier proprietary or prop desks took a hit on their options positions. These prop traders did not speculate on the direction of the rupee, instead they placed bets on the volatility of the currency, which is done by using a combination of rupee option contracts. Implied volatility (IV) — a measure of traders' expectations of risks in the markets immediately — is a key aspect for calculating options premium.  So, when uncertainty is high, IVs tend to shoot up, causing a surge in options premium.  IV of currency options, which was in the range of 2.5 to 4 in July and August, shot up to around 12 in September.  Though these prop traders were ready for the jump in IVs, they did not expect the measure to go up to 12. Many of these traders sold volatility (or sold the combination of call and put options) when IV was around 8. "The spike in vols over 8 was beyond their wildest of imaginations. The rise was so rapid that they found it difficult to square up positions. Many proprietary desks have been wiped out, as even a movement of one percentage in the currency can make a huge impact," said Dharam Chand Sethia, trader at Kolkata-based Kredent Brokerage, which runs a proprietary desk.  "When vols are 1.5-2% on a daily basis against a normal 2-2.5% per month, no strategy will work in a trade that's highly leveraged," said Hitesh Daga, director, Mumbai-based Hrim Finance, which runs a proprietary book and a jobbing desk. Severe losses have sucked volumes out of currency options. "Where options OI (open interest) was 50% of overall market open interest, it's now just 10%," said Daga.  "The rollover from October to November has been lower than that in the preceding month because of the losses. This has also cut the open interest as many people squared off at a loss and did not roll over," said Aggarwal.