China regulator said consider Yuan options trading by banks

China may allow options trading yuan to help banks and companies protect their profits from fluctuations in currency exchange rates, according to four people briefed on the plan.

The State Administration of Foreign Exchange, the country's currency regulator, has asked the opinions of some banks in the area, according to the people, who declined to be identified because the plan has not been announced. Trade can begin in two months, two people said. Options give the buyer the right, but not the obligation, to buy or sell currency at a specified price on a specific date.

Policy makers who seek to curb the fastest inflation in two years, may allow the yuan to rise 6.2 percent in late 2011. Senate Foreign Relations Committee chairman, John Kerry, said last week that Congress is "impatient" with the value of the yuan artificially low in China and may require legislation "with teeth" next year.

"We expect more volatility in the exchange rate of the yuan as the exchange rate system is constantly being renovated and the appreciation of the yuan is likely to accelerate," said Dariusz Kowalczyk, chief economist at Credit Agricole CIB in Hong Kong. "This implies a growing need for hedging tools."

The foreign exchange regulator did not respond to three phone calls and faxes seeking comment. An official of the China Foreign Exchange Trade System, which provides a platform for trade in yuan, declined comment.

Yuan gains

The Chinese authorities last allowed a new derivative of trade in the interbank market in the nation to adopt currency swaps in 2007. Derivatives are contracts whose value is derived from stocks, bonds, loans, currencies and commodities, or linked to specific events, such as changes in interest rates.

The People's Bank of China has allowed the yuan to strengthen by 2.4 percent against the dollar since scrapping a two-year dollar link on 19 June. Inflation accelerated to 5.1 percent last month, the fastest pace in 28 months, the statistics office said on 11 December. China's trade surplus was more than expected $ 22.9 billion in November, exports increased 35 percent over the previous year, the customs office said on December 10.

'Tools Limited'

China will push forward the reform of RMB exchange rate next year, according to a statement on the website of the State Council yesterday after the annual Central Economic Work Conference, attended by President Hu Jintao and Premier Wen Jiabao.

"There are very limited tools for businesses to hedge against exchange rate risks," said Liu Dongliang, Shenzhen-based analyst at China Merchants Bank Co., the country's sixth largest lender by market value. "Today's settlement may only use yuan or futures contracts to protect international trade."

Yuan options are traded outside China between banks and the Chicago Mercantile Exchange, the largest futures market in the U.S., began trading contracts in August 2006.

Shares in Citic Pacific Ltd., an arm of China's largest investment company owned, fell 55 percent on October 21, 2008 after he announced HK $ 14,700,000,000 ($ 1.9 billion) of potential losses arising from exchange offices.

Implied volatility

Chinese regulators have taken steps to help protect businesses against risks in derivatives after the U.S. on credit-triggered global crisis. Li Fuan, head of banking innovation of the China Banking Regulatory Commission, said China will "soon" issue new regulations on banks' business of derivatives, the Shanghai Securities News reported on 19 November.

the one-month implied volatility on the yuan against the dollar, a measure of fluctuations in the exchange rate used for pricing options, has risen to 3.75 percent from 0.45 percent at the beginning of the year. The currency weakened 0.17 percent to 6.6670 per dollar today, after gaining 0.12 percent last week.

The dollar a year, the risk-investment rate of 25 delta against the yuan was a negative 0.48 percentage point. A negative reading indicates that there is more demand for calls yuan, or the right to buy the currency, which makes, or the option to sell the currency.

China is promoting greater use of its currency in global finance and trade to reduce dependence on the U.S. dollar. In November, the central bank began allowing the yuan to trade against the Russian ruble in the interbank market.