NRI Trading in Derivatives

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With the growth of the Indian economy, more and more people are looking forward to investing in the Indian equity and securities trading market. These people aren’t just limited to Indian resident nationals. The government of India has allowed NRI Trading in Derivatives noting the keen demand for the same.

In this quick review, we will discuss how NRI trading in derivates is accomplished. We will also talk about the various options and restrictions for a Non-resident Indian while trading in India.

Let’s brush up some basics first!

NRI Trading in Derivatives Basics

Derivatives are financial instruments whose value vary upon fluctuations in the price of an underlying asset. This underlying asset can be a commodity, stock, currency, or anything of the like. Derivatives trading is done by betting on the fluctuations on the price of the derivative.

If the price moves in your direction, you earn a profit. Else, you incur the most unwelcomed ‘losses’!

NRI trading in derivatives can be done through two methods: Futures and options.

  • In futures trading, NRI creates a contract that he would be selling or buying the underlying asset at a future date and time. On that date and time, the NRI has to buy the asset as per his contract, unless his position is closed.
  • In Options trading, NRI also creates a contract to buy or sell the underlying asset at a future date and time. However, on that date and time, the NRI has no obligation to fulfil the contract. He may or may not do as per his discreet.

Both futures and options trading, while similar, both follow a different risk management technique. Both types of derivatives have their own way to implement successful trades.

As per government regulations, all NRIs trading in derivates is open for all NRIs. There are certain conditions that need to be met and a few restrictions.

NRI Trading in Derivatives – How to Begin?

To take part in derivative trading in India, an NRI needs to have a special Indian bank account. This account is called a Non-Ordinary Rupee (NRO) account.

Funds in this account can be used to manage finances in India. However, these cannot be directed to a foreign bank account without the permission of the RBI. They can be used within India only.

Once you have an NRO account, there are following necessities to be met in order to carry out NRI Trading in Derivatives:

Demat Account:

Demat is short for a Dematerialized account. It is an account that holds your money electronically for the purpose of trading. All the money that you will use to trade in Indian derivative market will come from this account.

This account of the client is connected to the NRO account. You can transfer money within these two accounts whenever you want.

Trading Account:

Trading account, as the name suggests, is the account that holds your representation in the asset you have purchased. It is the account you will use for buying and selling the asset. A trading account is linked to a Demat account.

Buying and selling assets in the trading account will reflect in the finances you hold in your Demat account. One trading account can be linked to one Demat account only.

Margin Maintenance:

This is the most important part which concerns only derivative trading in particular. If you are looking to perform NRI Trading in Derivatives, you will have to maintain a minimum margin requirement. Margin is a percentage of the asset you wish to buy. This is a compulsory need.

Margin is used as a security in case the value of the asset you have purchased decreases. The margin is used to invest more in the asset to keep up your share in the investment.

Position Limits for NRI:

SEBI has set a specific set of client level position limits. The same limits apply to the NRI as well. The positions limits for an NRI are:

Index Based Contracts: For all index-based contracts, there is a disclosure requirement for any person/persons acting in concert who together own 15% or more of the open interest of all derivative contracts on a particular underlying index.

Stock Options and Futures Contracts: For stock options and futures contracts, the gross open position across all derivative contracts on a particular underlying stock of an NRI shall not exceed the greater of

  • 1% of the free float market capitalization (in terms of the number of shares).
  • 5% of the open interest in the derivative contracts on a particular underlying stock (in terms of the number of contracts).
  • These position limits would be applicable to the combined position in all derivative contracts on an underlying stock at the exchange.

Make sure you understand the margin limits while carrying out NRI Trading in Derivatives.

NRI Futures Trading

If an NRI wants to take part in futures trading in India, there are various points he needs to take in mind. Future trading is settled only by cash in India. Therefore, it is non-delivery based trading.

For futures, the quantity, as well as the time of sale/purchase, is set in advance. The mode of trading is based on leverage instead of a full purchase. To understand the difference, take the following example:

Suppose you buy 100 shares of ABC bank at ₹1000 each. If the trade is based on a cash market, you will have to invest ₹1,00,000. Now, if the price of each share increases to Rs 1100, you will have a net profit of ₹10,000 (1000*(1100-1000)).

Now, take the case of a leverage-based market. Suppose you are given a 20% margin, you will have to invest only ₹20,000 for 100 shares at ₹1000 each. However, if the price per share increases to ₹1100, you make the same profit.

The biggest difference is – you don’t need high initial capital in order to make larger profits.

Future contracts have a maximum of 3 month expiry period in India. The unsettled contracts are settled based on the NSE index on the expiry date. The contract expiry date is on the last Thursday of the expiry month.

NRI Options Trading

NRIs are allowed options trading in the NSE.  There are various advantages in Options Trading. These include:

Options are based on the leverage concept, an NRI can use this to his benefit. He has a greater buying power to buy more of a particular asset than he could have in a cash-based market.

The Options Trading can be used for Speculation or Hedging. This reduces the risk of owning a share in an asset.

Options trading allows controlled exposure to risk for the NRI trading in derivatives. This is because the NRI has the choice to fulfil his buy-sell agreement or not. If the price of the asset does not go as he wishes, he can choose not to make the sale or purchase.

NRI Futures and Options Penalties:

Exchanges can charge various penalties in Futures and Options trading. An NRI trading in derivatives needs to be aware of this to save most of his money. These penalties include:

  • If the margin maintained by the NRI is less than the required margin, the exchange will charge a penalty.
  • If a Futures and Options position is taken but no margin is provided, a penalty will be charged.
  • There can be a penalty for the mark to market losses on position if these losses are not paid by the NRI.
  • If a client sells some options on a particular day and buys new options on the same day based on the premium he is to receive the next day, he will be charged a penalty.
  • If a client takes a Futures and Options position against the equity that is pending by the Exchange, he can be charged a penalty.
  • Positions taken against any other receivables can be penalized as well.
  • If an NRI exceeds the trades more than the client wise limit that the exchange has set for the NRI, he can be penalised.

Therefore, NRI trading in derivatives is not quite different from resident derivative trading. The major difference lies in getting a trading account opened. You can open your own trading account with the easy steps we mentioned and begin trading today.

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