Hedging Instruments: Swaps and Options
Beyond the forward: which swaps and options Indian users can take, and the conditions on every hedge.
A forward contract fixes a rate for a future date, and for most exporters and importers it is the whole hedging toolkit. Larger users and longer exposures need more: swaps to change the currency of a loan, and options to buy protection while keeping the upside.
RBI's hedging directions, in force since 5 April 2024, decide who can use which product, and attach the same conditions to every hedge that involves the rupee. CCFE tests both the products and those conditions.
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The Products, in RBI's Words
- Foreign exchange swap
- An actual exchange of two currencies (principal only) on a near date, and a reverse exchange of the same currencies on a later date, at rates agreed at the start. Banks use it to shift value dates, for example when an exporter delivers early under a forward.
- Currency swap
- A commitment to exchange streams of interest and/or principal in two currencies on set dates over the swap's life, at a pre-agreed exchange rate. Typically used to convert a foreign currency loan into a rupee liability, or the reverse.
- FX call option (European)
- The buyer gets the right, not the obligation, to buy an agreed amount of a currency at a fixed rate on a specified date. An importer buys calls.
- FX put option (European)
- The right, not the obligation, to sell an agreed amount of a currency at a fixed rate on a specified date. An exporter buys puts.
- Call or put spread
- Buying one option and selling another of the same type and expiry at a different strike. Cheaper than a plain option, with the protection capped.
- Covered option
- An option the user writes while holding the opposite position in the underlying: a covered call is written against a long position, a covered put against a short one.
Who Can Use What
Banks classify every user as retail or non-retail. Non-retail includes NBFCs, insurers, pension funds, mutual funds and AIFs, non-resident entities, and resident users with net worth of at least ₹500 crore or turnover of at least ₹1,000 crore.
Forward, FX swap, currency swap
Retail users
Yes
Non-retail users
Yes
Buy European call or put option
Retail users
Yes
Non-retail users
Yes
Buy call spread or put spread
Retail users
Yes
Non-retail users
Yes
Write covered call or covered put
Retail users
No
Non-retail users
Yes
Option to undertake or cancel a forward, swap or option
Retail users
No
Non-retail users
Yes
Other structured derivatives
Retail users
No
Non-retail users
Yes, except leveraged derivatives
| Product | Retail users | Non-retail users |
|---|---|---|
| Forward, FX swap, currency swap | Yes | Yes |
| Buy European call or put option | Yes | Yes |
| Buy call spread or put spread | Yes | Yes |
| Write covered call or covered put | No | Yes |
| Option to undertake or cancel a forward, swap or option | No | Yes |
| Other structured derivatives | No | Yes, except leveraged derivatives |
Conditions on Every Rupee Hedge
- check_circleThe same exposure cannot be hedged with more than one derivative contract.
- check_circleThe notional amount and tenor of the hedge cannot exceed the value and tenor of the exposure. If the exposure shrinks or ends, the hedge is adjusted.
- check_circleA user may hedge contracted exposure up to USD 100 million notional outstanding, across all banks, without having to prove the underlying. The underlying must still exist and be unhedged elsewhere.
- check_circleUsers may freely cancel and rebook contracts. But net gains on a hedge of an anticipated exposure are passed on only when the anticipated cash flow actually happens.
- check_circleFor retail users, the bank discloses the mid-market mark (the price before its margins) before the deal and in the confirmation.
- check_circleCurrency swaps that convert a rupee liability into a foreign currency liability are allowed for resident non-individuals; for retail users, only where a natural hedge exists.
Swaps, options and RBI's hedge conditions. No signup.
Older Notes Carry Older Rules
Courseware and question banks written before 2024 state restrictions the current directions dropped, for example that a cancelled swap cannot be rebooked at all, or that a cancelled forward can be rebooked only under special conditions. Where a question cites the current framework, the answer is free cancellation and rebooking, with the anticipated-exposure gains rule as the only brake.
How CCFE Tests This
Expect definition questions (swap versus forward, call versus put, what makes an option European) and condition questions (can notional exceed the exposure, what is the threshold for hedging without documents). The classic trap is direction: an importer fears a rising dollar and buys a call; an exporter fears a falling dollar and buys a put.
FAQs
What is the difference between an FX swap and a currency swap?expand_more
An FX swap exchanges principal on a near date and reverses it on a far date. A currency swap exchanges interest and/or principal streams in two currencies over the life of the deal, typically to change the currency of a loan.
Can a retail user write options in India?expand_more
No. Retail users can buy European calls, puts and spreads. Writing covered options is limited to non-retail users.
Can a hedge be booked without documents?expand_more
Yes, up to USD 100 million notional outstanding across all banks for contracted exposure. The user must still have a valid, unhedged exposure and be able to show it if asked.
Can forward contracts be cancelled and rebooked?expand_more
Yes. Current RBI directions let users cancel and rebook freely, but net gains on hedges of anticipated exposures are paid out only when the underlying cash flow occurs.
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