MANAGING EXPORT RISK
USING CURRENCY PUT SPREAD
One of the biggest risk factors involved in operating an Export business is that while the Local Purchase & Overseas Sale is in progress, the value of Indian Rupee may change in comparison to the value of U.S. dollar (assuming Export is with USA). This means that the business is open to risk in terms of adverse movement of US Dollar against INR. Companies doing exports are exposed to foreign currency risk (Risk of Dollar Rupee going down). They can manage this risk by using the following tools.
Selling Currency Futures
Currency futures is an exchange-traded contract that specifies the price of one currency at which another currency can be bought/ sold on a future date. Currency Future contracts are non-deliverable contracts and need to be cancelled on or before expiry date. If the Company does not cancel the contract, then the contract is automatically cancelled at RBI reference rate on Expiry Date.
For Details on this strategy read my Article dated 28 December 2020 Click here
Buying Put Option
A put option is a contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a pre-determined price (Strike Rate) on a specified date (Expiry date).Put option hedges the downside risk fully while keeping the upside open. It has a limited loss and unlimited gain potential.
For Details on this strategy read my Article dated 11 January 2021 Click here
Buying Put Spread
A put spread is an option spread strategy that is created when equal number of put options are bought and sold simultaneously with different Strike Price for same Expiry Date. Unlike the put buying strategy, the downside risk is not fully hedged. The profit potential is unlimited and it is cheaper to buy in comparison to simple Buy Put strategy.
Mr Bharat is a shirt exporter and he has a contract to supply shirts worth US dollar 10,000 in the month of January 2021.The cost of making a Shirt is Rs. 72. Mr. Bharat is expecting export payment in the month of February. The current rate (Spot rate) is 73.00 and one-month future currency is 73.20. If he uses BSE Currency Future Contract, he will be gaining Rs 1.20 as total profit per shirt. If Dollar Rupee goes above 73.20, he will not be able to get benefit of favorable market movement. He decides to use Put Spread to Manage the Risk.
Current Rate of 73.00 put Expiry 26 Feb 2021 is 0.26 and for 72.50 strike with same Expiry is 0.10
- BUY 73.00 PUT Expiry 26 FEB 2021 at 0.26 paise (PAY)
- SELL 72.50 PUT Expiry 26 FEB 2021 at 0.10 paise (RECEIVE)
To conclude buy BSE Currency Put spread is also an option for an exporter to hedge the Currency Risk. The downside risk is protected up to a point (72.00 in our case) and the exporter gets an advantage if the market moves in his favor i.e. Dollar Rupee starts going up. The Cash flow of Hedged strategy is better than Unhedged in case of Dollar Rupee going down. The net premium of Put Spread is 0.16 paise as compared to 0.26 paise in case of Buy PUT strategy. The strategy is to be used when the Exporter expects the market to go up with limited downside move. In our case Mr Bharat is not expecting Dollar Rupee to go below 72.00 by Feb 2021 and he feels that 73.00 or 74.00 is more likely that is why he used this strategy.