IPO season is going on and a lot of people asked to explain how IPO related flows impact local currency and what's the difference between bringing dollar on outright basis vs on hedged basis. Here's an attempt by us at @kotaksecurities.
There are two parts to any IPO - anchor book, which opens one day prior to IPO (Nov 3) and second is, book building portion (Nov 8-10), when IPO goes live. These dates are for Paytm IPO.
In case of Paytm IPO, it is India's largest IPO at 18.9K crs and so is the anchor book, which is approx 8.5k crs. Since 1/3rd of anchor book to be allocated to MFs, net anchor book for FPIs is 5.7k crs. All these numbers are calculated at higher price of the range - 2150.
Since IPOs are time abound exercise spread over 4-5 days, excluding holidays, it has impact on local currency, if they attract decent interest (flows) from foreign investors. Today, rupee is seeing downward drift and looks to be largely on account of IPO related flows.
As stated in the past, now a days, flows related to anchor investor portion seems to have bigger impact on INR than book building portion, as in anchor book, FPIs bring dollar on outright basis, while in later, large part of the flows may come on hedged basis (sell-buy swap).
Sell-buy swap is a strategy where FPIs sell USDINR, say today, to buy it later, say 6/7 days, by paying the premium amount. In this, since one is doing both the buy and sell at the same time, there is no impact on spot; against outright, where one just sells dollar. 💰
In book building portion, since it is not clear how many times the IPO is likely to be subscribed, foreign investors prefer to do sell-buy swap, so that if he/she gets just 10%-20% of the total allocated amount of total bid, there is no FX risk on the rest of 80%-90% amount.
Against this, when one bids in anchor book, foreign investors in general have a fair idea that how much is the likely allotment. Hence they bring dollar only to that extent, but on outright basis, thus having larger impact in USDINR, which we are most likely seeing today.
The impact also depends upon the size of IPO, both book building and anchor.
Sometimes, we may see the impact on USDINR during book building portion as well if foreign investors bring lesser amount of funds on hedged basis. But in general, no one wants to take un-necessary FX risk.
Imagine, one brings in $100 mio dollar at 75 for IPO and gets allotement only for, say $20 mio and by the time, reversal happens 6-7 days later, USDINR moves up to 75.50. One ends up getting hit on $80 mio, against just paying 0.06/0.07p premium under sell-buy swap.
That's why it is always better to be hedged, even when doing any trading strategy, than going naked (not hedged).
Hope this helps to make things clear around IPO related flows. Since, we are having slew of IPOs lined up, one needs to keep these things in mind. But equally important to understand, the size and interest from FPIs. We may not see similar interest in all IPOs.
Finally, it is also important to understand , esp. in tech IPOs, if any of the foreign investors exiting and what is the quantum. If it is large, it can have impact on other side of #USDINR. Look for one.
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Today is weekly expiry (Nov 3) for currency at 12:30 pm. First half of the day until expiry, USDINR may trade soft as it also coincides with Paytm anchor book opening. Anchor investors who would not have converted their dollar yesterday has to do today, before putting in the bid.
Though, it is expected that large part of conversion would have happened yesterday itself.
Today is also an important day for financial markets, as FED meeting is there in late evening. The reaction of the same will be felt tom but since we are closed and has only one hour of Muharat trading, need to be cautious.
I have been talking about USDINR for some time. But one cannot trade comfortably in the product unless understand how the underlying moves. And the best way to understand is historical volatility over different time frame.
Given that equity has India VIX as a reference point, currency does not have as of now. We are looking at how we can help the option traders with this data point. Will come back on this.
But let's today focus on historical volatility. Right now volatility in USDINR is sub 4% but it is not the lowest. It almost touched 3% in Feb'20.
India FX reserves has grown over the year and is now the world's 5th largest.
So, what is the significance of this number - FX Reserves?
FX reserves basically represent the total foreign currency holdings that RBI has. Higher the reserves, better it is for the stability of it's currency.
Want to understand what makes #USDINR interesting from an individual #option trader perspective.
Let's try to understand this in this thread. USDINR has both weekly and monthly options contract which are fairly liquid. Today was weekly expiry.
Weekly options expire every Friday at 12:30 pm and monthly options at 2 days prior to last working day of the month. Margin applicable in USDINR is normally between 2.5% to 3% depending upon volatility.
Margin for one lot of USDINR #straddle (74.50 July 30 expiry - weekly contract) is roughly Rs. 2600/2700 and premium received is around 35p, which on one lot comes to Rs. 350 ($1000*0.35).
Sometimes, regulatory changes have asymmetric impact on different products within same eco-system. Peak margin seems to be one, having salutary effect on currency volume on Indian exchanges.
Currency volumes on Indian exchanges (NSE + BSE) seem to be gaining momentum this year, after an almost flat volume growth over the last 3 years. Until June end, ADV is up by almost 31%.
But what is interesting to note is increasing option share in total volume.
Since Dec'20, when peak margin got introduced, option share in total volume (futures+option) is slowly inching up, thanks to increasing interest in weekly options contract + possible peak margin effect.