JPMorgan Recommends Options as Indian Rupee May Slide

By Anil Varma

Sept. 9 (Bloomberg) -- Investors should use currency options to guard against losses as India's rupee heads for the steepest slide since 1991, when a balance of payments crisis forced the nation to pawn its gold, JPMorgan Chase & Co. said.

Investors should buy rupee put options granting the right to sell the currency against the dollar, said Vikas Agarwal, a strategist at the third-biggest U.S. bank. The rupee will fall to a two-year low by Dec. 31 as funds pull money out of emerging markets, he said.

``The odds of further rupee losses are more as fund flows stay weak,'' Mumbai-based Agarwal said in an interview. ``Added losses will stoke expectations of prolonged rupee weakness, and the ensuing adjustment in the currency would be swift, sharp and potentially disruptive.''

JPMorgan recommends buying options as ``insurance'' against such a slump, forecasting the Indian currency will drop to 45 per dollar, its lowest since November 2006, by the end of this year. It traded at 44.89 against the dollar as of 9:58 a.m. in Mumbai. Such a decline would take the year's loss to 12.4 percent, the most since 1991's 29.7 percent, according to data compiled by Bloomberg.

The rupee is the third-worst performer among the 10 most- active Asian currencies this year with a 12.2 percent loss. The currency advanced 12.3 percent in 2007, the biggest gain since at least 1974.

Investors should buy a rupee put and with a so-called strike price of 47, which is 3.8 percent higher than the rupee- dollar contract due by the end of December in the currency forward market. Forwards are agreements to buy and sell assets at current prices for delivery at a specified time and date.

`Rupee Volatility'

``Although this option isn't cheap anymore due to increased rupee volatility, it still protects against outsized losses in the currency,'' Agarwal said.

Implied volatility on one-month dollar-rupee options rose to a one-year high of 11.6 percent yesterday, Bloomberg data show. Traders quote implied volatility, a gauge of expected swings in exchange rates, as part of option prices.

Options are derivative contracts that give the holder the right to buy or sell an asset without the obligation to do so. A strike is the price an option holder may buy or sell a currency. Forward rates adjust for interest-rate differentials between currencies.

The rupee is headed for a third quarterly loss as overseas investors pulled out almost $7.5 billion from local equities this year. India's benchmark share index has lost 27 percent this year, following 2007's 47 percent advance.

``Capital inflows have slowed to a trickle and a sustained near-term rebound looks unlikely owing to a still tentative global backdrop for risk-taking,'' Agarwal said.

Current Account

The rupee will also weaken as the South Asian nation's current-account deficit widens, he said. The deficit, a measure of trade and investment flows, increased to $17.4 billion in the financial year ended March 31 from $9.8 billion in the previous year, central bank data show.

India's central bank may ``check the possibility of runaway rupee weakness'' by intervening in the local currency market to sell dollars, Agarwal said.

Dollar sales by the Reserve Bank of India in June exceeded purchases for the first time in 20 months, a central bank report showed last month. The monetary authority sold $7 billion during the month and bought $1.77 billion, taking net sales to $5.23 billion. The Reserve Bank's foreign-exchange reserves have declined by almost $21 billion from a record high of $316.2 billion reached in May, indicating it sold dollars.

1991 Crisis

India faced a balance of payments crisis in 1991 when the Iraq war sent oil prices higher, inflating the South Asian nation's import bill and depleting its reserves. That forced the country to pledge its gold reserves with the International Monetary Fund to borrow foreign exchange to pay for imports.

A falling rupee will stoke demand for options designed to protect against currency losses, boosting the value of such contracts, Agarwal said.

``That would give an opportunity to unwind the option with a profit before it expires, by selling a similar contract at a higher price,'' he said.

To contact the reporters on this story: Anil Varma in Mumbai at avarma3@bloomberg.net.