Exchange Control - Introduction of Foreign currency- Rupee Options
[Source:A.P.(DIR Series) Circular No.108 Dated June 21, 2003]

As a part of developing the derivative market in India and adding to the spectrum of hedge products available to residents and non-residents for hedging currency exposures, it has been decided to permit foreign currency rupee options with effect from July 7, 2003. Authorised dealers will be permitted to offer the product under the following terms and conditions:

This product may be offered by authorised dealers having a minimum CRAR of 9 per cent, on a back-to-back basis.

Authorised dealers having adequate internal control, risk monitoring/ management systems, mark to market mechanism and fulfilling the following criteria will be allowed to run an option book after obtaining a one time approval from the Reserve Bank:

• Continuous profitability for at least three years

• Minimum CRAR of 9 per cent

• Net NPAs at reasonable levels (not more than 5 per cent of net advances)

• Minimum Net worth not less than Rs. 200 crore

• Initially, authorised dealers can offer only plain vanilla European options.

Customers can purchase call or put options

Customers can also enter into packaged products involving cost reduction structures provided the structure does not increase the underlying risk and does not involve customers receiving premium.

Writing of options by customers is not permitted.

Authorised dealers shall obtain an undertaking from customers interested in using the product that they have clearly understood the nature of the product and its inherent risks.

Authorised dealers may quote the option premium in Rupees or as a percentage of the Rupee/foreign currency notional.

Option contracts may be settled on maturity either by delivery on spot basis or by net cash settlement in Rupees on spot basis as specified in the contract. In case of unwinding of a transaction prior to maturity, the contract may be cash settled based on the market value of an identical offsetting option.

All the conditions applicable for booking, rolling over and cancellation of forward contracts would be applicable to option contracts also. The limit available for booking of forward contracts on past performance basis- i.e. contracts outstanding not to exceed 25 per cent of the average of the previous three years’ import/export turnover within a cap of USD 100 mio- would be inclusive of option transactions. Higher limits will be permitted on a case-by-case basis on application to the Reserve Bank as in the case of forward contracts.

Only one hedge transaction can be booked against a particular exposure/ part thereof for a given time period.

Option contracts cannot be used to hedge contingent or derived exposures (except exposures arising out of submission of tender bids in foreign exchange).

Customers who have genuine foreign currency exposures in accordance with Schedules I and II of Notification No. FEMA 25/2000-RB dated May 3, 2000 (Foreign Exchange Management (Foreign exchange derivative contracts) Regulations, 2000) as amended from time to time are eligible to enter into option contracts.

Authorised dealers can use the product for the purpose of hedging trading books and balance sheet exposures.

Authorised dealers wishing to run an option book and act as market makers may apply to the Chief General Manager, Reserve Bank of India, Exchange Control Department, Forex Markets Division, Central Office, Fort, Mumbai-400001 with a copy of the approval of the Competent Authority (Board/Risk Committee/ALCO) and a copy of the detailed memorandum put up in this regard. Authorised dealers who wish to use the product on a back-to-back basis may keep the above Division informed in this regard.

Market makers would be allowed to hedge the ‘Delta’ of their option portfolio by accessing the spot markets. Other ‘Greeks’ may be hedged by entering into option transactions in the inter-bank market. The ‘Delta’ of the option contract would form part of the overnight open position. As regards inclusion of option contracts for the purpose of 'AGL', the ''delta equivalent" as at the end of each maturity shall be taken into account. . The residual maturity (life) of each outstanding option contracts can be taken as the basis for the purpose of grouping under various maturity buckets. ( For definition of the various ‘Greeks’ relating to option contracts, please refer the report of the RBI Technical Committee on foreign currency-rupee options -- relevant extracts are given in Annexure II).

For the present, authorised dealers are expected to manage the option portfolio within the risk management limits already approved by the Reserve Bank.

Authorised dealers running an option book are permitted to initiate plain vanilla cross currency option positions to cover risks arising out of market making in foreign currency-rupee options

Banks should put in place necessary systems for marking to market the portfolio on a daily basis. FEDAI will publish daily a matrix of polled implied volatility estimates, which market participants can use for marking to market their portfolio.