Indian exporters chasing quick buck stung as rupee slide unravels exotic trades

The lure of quick profits drew some Indian exporters to an exotic option structure when the rupee was rangebound. A handful of them are now facing margin calls and losses due to the currency’s sharp decline, according to three bankers. The structure, called a target redemption forward (TARF), allows exporters to sell dollars on fixed dates, usually a month apart, at a predetermined rate which is significantly better than what they would get by selling forward dollars.

However, profits under TARF – the difference between the pre-determined rate and the spot rate on the fixed dates – is capped and the option is terminated automatically when the limit is reached.

When rupee was in a narrow range, this profit cap was reached well before the duration of the TARF option, an ideal scenario for exporters, a forex and derivatives sales person a bank said, declining to be identified because he is not authorised to speak to the media.

Exporters were drawn to TARF by the promise of these quick profits, he said.At the time the options were sold, the rupee was trading in a narrow band of 83 to 84 and volatility was expected to remain low.

Things have since changed with the rupee plunging 3% over the last three months to an all-time low of 86.6475 and volatility climbing to multi-month highs. This means that the profit cap on the TARF structure has not been reached and exporters are now having to sell dollars at lower than the forward rate. “TARFs, which were marketed in the low volatility set up are suffering huge mark-to-market (MTM) losses,” an fx salesperson at another bank said.

“We are constantly getting reports (from the risk management team) on the MTM losses and have to see if additional collateral cushion is required.”

The TRAF structure was popular with only a few large and mid-sized corporates and hedging via this structure was a tiny percentage of their overall exposure, bankers said.

“The issue with TARF is the asymmetric payoff i.e., the potential profits are limited, whereas the potential loss is unlimited,” Samir Lodha, managing director at risk management advisory firm QuantArt Market Solutions.