Trading in currency futures will soon become a reality for the retail investor. With the Reserve Bank of India [Get Quote] and the Securities and Exchange Board of India issuing trading norms, exchanges are readying themselves to launch this product in the next few weeks.

The new norms would help retail investors, especially those investing abroad and families receiving incomes from relatives in foreign countries. According to a financial planner, currency futures can also be used to hedge the investments in gold. Till now, only business houses were allowed to trade in currency futures to minimise the risks arising from currency fluctuations.

Currency futures are contracts to buy or sell one currency (only dollar-rupee as of now) against another at a specified price and date in the future. The National Stock Exchange is planning to start currency futures trading from August 29. The Bombay Stock and the Multi-Commodity Exchange are yet get clearance from Sebi to start operations.

An Indian resident would be required to open an exchange-traded currency futures account with a recognised broker. The minimum trading amount will be $1000. The trading period will range from one month to 12 months and the contract will be settled on the basis of RBI's reference rate on the last trading date.

Experts are cautious though. "This is not an investment avenue like stocks. Retail investors should use it only for hedging against their foreign investments," said Sudip Bandyopadhyay, director and CEO, Reliance [Get Quote] Money.

Let's look at how this will work:

For instance, a person invests $200,000 abroad for a year when $1 = Rs 43. If his investments yield 20 per cent returns in a year, he stands to make $40,000, or Rs 17.2 lakh ($40,000 * 43) in rupee terms. However, if the dollar weakens to Rs 40, the returns would fall to Rs 16 lakh, a loss of Rs 1.2 lakh.

But if the person had sold a 12-month futures contract at the spot price of Rs 43, amounting to $200,000, and the dollar did fall to Rs 40, he could cover the transaction by buying the dollar and make good the loss incurred in the international market.

The upfront payment will be 1.75 per cent of $200,000 or $3,500. Of course, in case the rupee weakens to say 45, the losses in the futures market would be made up by profits in the international market. Jayant Manglik, head (commodity business), Religare Commodities, said, "The investor is hedged against both a rise and fall in currency, thereby ensuring safe returns."

No taxation guidelines have been formulated as yet, but Uday Ved, head of taxation, KPMG said the transactions could be considered as business income. "It (currency trading) can not be classified as speculative income as the trading would take place through a stock exchange nor can it be capital gains as there is no underlying capital asset," said Ved. There would be a securities transaction tax of 0.017 per cent, as is applicable to other traded derivative products.