Option traders take risky bets on unusually calm rupee

Currency traders are taking ever more risk playing the unusually calm Indian rupee, selling options that pay them pennies if it stays where it is but expose them to potentially unlimited losses if it breaks out of its tight range.

The cohort are essentially making a bet that the Reserve Bank of India will continue to keep a tight grip on the currency as it seeks to contain volatility and slow its decline past a record low. But they put themselves at risk of a sudden policy shift or any external shock that sends the rupee spinning.

Speculators are taking advantage of the quiet to sell both call and put options on the Indian currency, according to traders and analysts at institutions, including Kotak Securities Ltd and Shinhan Bank India. For example, there’s a concentration of call options at the 83.50 to 84.00 per dollar level, according to data compiled by Bloomberg.

The Indian currency traded around the 83 level on December 15 and has been stuck in a narrow range for at least three months. It has become one of the world’s least volatile, thanks to repeated interventions from the RBI.

“The only thing the speculators are doing, is they are shorting options, which invariably leads to a very quiet market,” said Anindya Banerjee, currency analyst at Kotak Securities. “Things can become dangerous if you have a short squeeze.”

Selling options in a range-bound currency will remind some of the old market adage “picking up pennies in front of a steamroller.” Income is capped at the premium received, while losses are unlimited when volatility surges and traders are forced to chase markets to close positions.

In 2018, the “Volmageddon” episode of an unexpected surge in volatility added to a 10 percent plunge in the S&P 500 over two weeks. The Swiss franc explosion, where the currency rapidly appreciated against its major peers after the central bank’s surprise decision to abolish its ceiling was another instance. It caused losses of hundreds of millions of dollars at banks like Barclays Plc. and Deutsche Bank AG.

In India’s case, RBI intervention has dried up opportunities to make money from intraday swings, pushing some to turn to the options market. While the rupee gained 0.4 percent to 83.0013 on Friday, its 0.5 percent advance since the Federal Reserve’s pivot earlier this week is among the lowest in Asia.

The outstanding exposure on calls expiring in December with strikes above the underlying spot price – up to 84 – is $1.3 billion, while for the same expiry puts – with strikes below the current spot price up to 83 – is about $1.2 billion, based on data compiled by Bloomberg.

“Given the current scenario, it is in favour of the traders but a sudden move against them or any increase in vols can add as a risk,” said Kunal Sodhani, vice president at Shinhan Bank India. “Nothing much is happening on the spot, thus at this time, it is turning a good trade to make money.”

Risk Galore

For example, a trader can sell a dollar call option with a strike of 83.50 and pocket a premium of 0.04 rupees per contract, assuming the underlying spot is at the same level. She keeps the premium if the contract expires below that level on expiration. Her risk lies in a dollar rally, forcing her to liquidate the position, potentially adding to the greenback’s rally.

“The crowded trade is piling up here,” said Arnob Biswas, head of FX research at SMC Global Securities. “If by any chance 83.50 breaches, then a lot of stop losses will get triggered. Options writers will try to quickly square up their positions and that will add to a lot of upward momentum in the dollar-rupee.”

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