Re options turn costly as premia jump four times

MUMBAI: Increased volatility in the spot rupee market has made it more expensive for banks and exporters to pick up rupee options. Option premia have gone up almost four times in the past few weeks. This is a consequence of high levels of volatility in the spot market in the past month. The rupee has weakened by almost 10% in the past month, plummeting to record lows of 49.88 against the dollar on Thursday.

As on Thursday, one-year rupee options carried a premium of around Rs 2.5 per dollar compared with levels of 80-90 paise a month ago. There are four main parameters, which go in to the calculation of the option premia ��� the tenure, interest rates, strike price, and most importantly, the volatility. According to market participants, the implied volatility has gone over the 12%-levels, while generally accepted levels are around 6-7%.

A rupee option is basically a contract that enables a bank or corporate to buy rupees at a certain pre-determined price at a later date. To enter such contracts, the participants have to pay a premium, which is known as the option premium. For example, a bank could have entered into a contract last month when the rupee was at the 45-levels, to buy rupees at the 47-levels. So with the rupee around the 49-levels, the bank would make a killing.

However, with the volatility in the market rising considerably, option premia have increased as well. Moreover, the participants are not under any kind of compulsion to actually buy rupees at the said level, in which case the premium is forfeited.

HDFC Bank chief economist Abheek Baruah said, ���The rise in option premia is a function of the volatility in the spot rupee market. Most people expect the rupee to depreciate further as well. There are out-of-money options
being entered which carry a significant premium.���

Meanwhile, market participants continue to be apprehensive about the local unit in the near term, with many of them seeing it touch the 53-levels in the near-term. ���The rupee has been moving by 5-10 paise on a daily basis. This has led to a substantial increase in the implied volatility in rupee-dollar contracts. The rupee at the moment is in a very vulnerable state with high levels of international dependence,��� explained KN Dey, director of Basix Forex.

Offshore markets like the non-deliverable futures (NDF) market project a bearish outlook for the rupee as well. One-month offshore NDF contracts quoted at 51.79/94 per dollar, nearly 4% weaker than the onshore spot rate. This has also proved to be a significant arbitrage opportunity for foreign banks, which have been aggressively buying
dollars at the domestic spot market while selling them at the offshore NDF market.