How to hedge currency risk with Interactive Brokers?

This is a discussion on How to hedge currency risk with Interactive Brokers? within the Brokerages forums, part of the Commercial category; Hi guys, I've got a GBP account with interactive brokers via a Limited company and I've been making some trades ...

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Old May 20, 2016, 11:42am   #1
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How to hedge currency risk with Interactive Brokers?

Hi guys,

I've got a GBP account with interactive brokers via a Limited company and I've been making some trades in the US markets for the last 3 months or so but in most of the trades I've ended up giving back part of the profit when closing the trade and converting back from USD to GBP.

I've read some comments on the forum about this subject but I didn't manage to see how is this currency risk actually hedged with Interactive Brokers?

For example, if I'm investing £30,000; what is the best way/instrument for hedging the investment against currency fluctuations when buying a USD stock with GBP funds?

Thank you!
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Old May 23, 2016, 1:38pm   #2
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mickael28 started this thread Hiya,

Do you guys think this question would be better asked in a different section of the forum? I'd like to see a practical example of how it's done to try with my Interactive Broker demo account first and after with the real one...

At the moment I've tried using the FX hedge options that one has when entering a trade in a different currency (FX conversion and FX Ideal Pro) but, it seems that in both cases you are still exposed to the currency risk anyway.

Any idea what I should try?

Thanks
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Old May 24, 2016, 5:12am   #3
 
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You have no real currency risk, because IB lend you the currency in which you buy.

Example:

GBP.USD = 1.50... USD 150k = GBP 100k

You buy USD 150k worth of stocks... IB will lend you de USD 150k to buy it with, which is a debt (-/-) and the stocks in USD is an asset (+/+). And off course you still have the GBP you had to start with.

If GBP.USD goes to 1.00 and stock price stays the same, you still have USD 150k worth of stocks against USD 150k loan.

When you sell the stocks at that price, you receive back USD 150k is cash, which cancels out the loan.

So... no currency risk. Except for stock price moves... (which might happen because of forex moves, but that's another thing).

If you make a profit on your stocks, let's say you sell for USD 160k... Then you wil lend up with a positive USD cash balance of 10k.... So in effect, you have currency risk on your P/L only.
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Old May 25, 2016, 2:01am   #5
 
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If you want no currency position, then don't do anything when you buy foreign stocks... because, as I mentioned, IB lends you the currency and then effectively you don't have a currency position.
(+/+ USD stocks and -/- USD loan...). But then you do need to pay the interest rate on the loan (1.7% currently).

Alternatively, buy back the stocks and buy back the USD amount to cancel the IB-loan (sell GBP.USD on spot market). Now you do have a USD currency position (150k long). Then hedge the USD-position back to GBP by buying the GBP.USD future... (underlying is USD 62.500, so buy 1 Future at 1.46 is USD 91.250).

The hedge through the future gives you a better, more market conform, interest rate. But, you will need to rollover the future on expiry....

This way is more difficult. I wouldn't do it if you intend to keep the stocks not too long... If you're not too advanced in your trading, don't make it too difficult. ( K.I.S.S. is the principle).
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Old May 25, 2016, 11:10pm   #6
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Futures (continuous vs rollover) vs forex trades when hedging?

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Originally Posted by JackRab View Post
Alternatively, buy back the stocks and buy back the USD amount to cancel the IB-loan (sell GBP.USD on spot market). Now you do have a USD currency position (150k long). Then hedge the USD-position back to GBP by buying the GBP.USD future... (underlying is USD 62.500, so buy 1 Future at 1.46 is USD 91.250).

The hedge through the future gives you a better, more market conform, interest rate. But, you will need to rollover the future on expiry....
Thanks for the explanation JackRab... I've stopped now converting the currency for the trades that I expect will be shorter term, however I still have some positions that will be there long term and I'd like to learn how to hedge them.

A few more doubts if you have knowledge about this pls?

If I've got an amount of GBP 50,000 that I'd like to hedge I've seen in Interactive Brokers that one can choose different options:
* GBP futures (6B contract) with the contract unit 62,500 GBP
** with options of continuous or 3m expirations
* M6B futures (micro contract) with the contract unit of 6,250 GBP
** with options of continuous or 3m expirations
* GBP.USD forex
Q1- Do you know which instruments are better for the purpose of hedging the currency risk? eg:
Checking their requirements, the GBP.USD forex trade seems to be the one that requires less margin (around £1000 GBP vs £3000 GBP for the futures option), wouldn't that be better than the futures option?

Q2- Regarding the futures, if there's an instrument for a continuous future, wouldn't that be better than getting the 3 months one and having to roll it over every 3m?

Q3- And if the rollover option is better for a reason, does that rollover happen automatically if you keep the position opened? or they close the opened position for you at the end of one contract and you need to manually login to enter a trade for the new contract yourself?

Many thanks...
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Old May 26, 2016, 6:08am   #7
 
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Quote:
Originally Posted by mickael28 View Post
T]

Q1- Do you know which instruments are better for the purpose of hedging the currency risk? eg:
Checking their requirements, the GBP.USD forex trade seems to be the one that requires less margin (around £1000 GBP vs £3000 GBP for the futures option), wouldn't that be better than the futures option?

Q2- Regarding the futures, if there's an instrument for a continuous future, wouldn't that be better than getting the 3 months one and having to roll it over every 3m?

Q3- And if the rollover option is better for a reason, does that rollover happen automatically if you keep the position opened? or they close the opened position for you at the end of one contract and you need to manually login to enter a trade for the new contract yourself?

Many thanks...
A1- comes down to costs I guess. If you have GBP 50k in cash and want to sell that to buy USD 75k... than you don't have to post margin, because it is in positive cash. If either one, GBP or USD ends up in negative cash balance, then you start to post margin... because you only look at margin when you have a negative balance. But GBP zero balance and USD 75k pos balance means no margin.

Again, if in your case you buy USD stocks with GBP cash balance, then you post margin on the USD loan, and you pay interest on negative USD cash balance. (position is now +/+ USD Stock; +/+ GBP Cash; -/- USD Cash). No USD currency risk.

If you buy back the USD balance and sell the GBP balance to 0, then no margin. (position is now +/+ USD Stock; no cash balance). But you then create a USD currency risk. Which you could hedge with GBP.USD future. Remember, the margin you post is not a cost... it's still yours, but you provide that as a safeguard. If the USD drops against GBP, you make a loss on your futures position and you need to post more margin... but that's not really a loss, since it's a hedge, you make money on the conversion to GBP of the stock position. Just make sure you can make the margin payments.

A2- The continous future is only for data and charting. Not as a trade (https://www.interactivebrokers.com/e...continuous.htm).
I don't think that IB has an option to rollover your position on expiry... The "Automatic Futures Rollover" is also purely for data, so the new future is added to your chart or watchlist. I personally wouldn't trust anybody else on a rollover anyway. They do send out a message when you have an open position on expiry I think... (http://ibkb.interactivebrokers.com/node/568)

A3- see A2

Again, KISS... (keep it simple stupid)... Doing the futures hedge is the cheapest if you look at interest rate on negative balances etc, but more of a hassle to do...
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Old May 26, 2016, 6:13am   #8
 
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Also, you can get really creative by trading currency options or options on currency futures!!!
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Old May 26, 2016, 11:58pm   #9
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If you buy back the USD balance and sell the GBP balance to 0, then no margin. (position is now +/+ USD Stock; no cash balance). But you then create a USD currency risk. Which you could hedge with GBP.USD future.
Yeah, I know there are quite a lot of different ways to achieve a similar result, but I'm not touching options for anything just yet, too much to digest at the some point in time

I need to try on the demo account with the 6B GBP futures contract and with the GBP.USD forex trade and see what's the difference in practice. I had always heard what you mentioned now as well about using futures for this case as the best available option, but briefly looking yesterday to my IB account I noticed that for a GBP.USD forex trade one seemed to need less margin (and I don't think one has the added task of the rollover for a forex trade)... hence that it sounds better than going with the futures way in that sense, but I don't remember of anyone recommending a forex trade over a futures one for hedging, so I might be missing something in this scenario...
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Old May 27, 2016, 1:00am   #10
 
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Originally Posted by mickael28 View Post
but I don't remember of anyone recommending a forex trade over a futures one for hedging, so I might be missing something in this scenario...
Well, if I hedge I use forex, purely because you can trade any size... futures hedge is limited to the contract size... you can trade mini's but I think the spread is larger as well. And I don't worry too much about margin or interest rate since I mainly trade shorter term.
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Old Oct 8, 2016, 8:28pm   #11
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Originally Posted by JackRab View Post
You have no real currency risk, because IB lend you the currency in which you buy.

Example:

GBP.USD = 1.50... USD 150k = GBP 100k

You buy USD 150k worth of stocks... IB will lend you de USD 150k to buy it with, which is a debt (-/-) and the stocks in USD is an asset (+/+). And off course you still have the GBP you had to start with.

If GBP.USD goes to 1.00 and stock price stays the same, you still have USD 150k worth of stocks against USD 150k loan.

When you sell the stocks at that price, you receive back USD 150k is cash, which cancels out the loan.

So... no currency risk. Except for stock price moves... (which might happen because of forex moves, but that's another thing).

If you make a profit on your stocks, let's say you sell for USD 160k... Then you wil lend up with a positive USD cash balance of 10k.... So in effect, you have currency risk on your P/L only.
Hi @JackRab, I've been now trading foreign stocks (US stocks from my UK account) for a while without using the option IB has for hedging currency risk but now that I check the report they create I can see that every time I borrow the US currency they enter the FX rate under the cost price column and then it seems they track this FX rate under the Close Price column.

After reading your explanation above I thought that if I borrowed $59647, like in this case, I was just going to pay interests in that amount but I was not going to have exposure to the USD.GBP currency on that capital (just on the profit/loss).

Do you understand what the 'unrealized P/L in GBP' column mean? It seems to me that because they're logging FX price when the trade was initiated and at present, I have incurred a loss of -£1581 so far (on top of the interests I am paying?

Or am I misunderstanding the meaning of that column?

This is the report:
Click the image to open in full size.
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Old Oct 10, 2016, 3:50am   #12
 
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Quote:
Originally Posted by mickael28 View Post
Hi
Do you understand what the 'unrealized P/L in GBP' column mean? It seems to me that because they're logging FX price when the trade was initiated and at present, I have incurred a loss of -£1581 so far (on top of the interests I am paying?

Or am I misunderstanding the meaning of that column?

This is the report:
Click the image to open in full size.
So you've bought USD 60k worth of stocks right? And effectively IB has lend that USD amount to you to buy the stocks with?

So, on the loan you do lose that amount, but on the other side your GBP value of the stocks is up by the same... (if the stocks are at the same USD price that is).

If the stocks are still worth the initial USD 60k... than in GBP that will be more than when you bought them, which should cover the GBP 1.580,- loss...

That forex balance statement is basically the FX only... not including the stock position.

Cheers JR
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Old Oct 10, 2016, 12:05pm   #13
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Originally Posted by JackRab View Post
So you've bought USD 60k worth of stocks right? And effectively IB has lend that USD amount to you to buy the stocks with?

So, on the loan you do lose that amount, but on the other side your GBP value of the stocks is up by the same... (if the stocks are at the same USD price that is).

If the stocks are still worth the initial USD 60k... than in GBP that will be more than when you bought them, which should cover the GBP 1.580,- loss...

That forex balance statement is basically the FX only... not including the stock position.

Cheers JR
Thank you for the explanation JR, I think I got it now.

So in my case, it's not like I'm going to pay the borrowed $60K with GBP funds and incur that loss at that time, I'll just pay it back when I sell the stock (directly in USD). So what you mentioned, if the stocks are still worth $60K, there would not be currency risk (just the interests paid on the loan), right?

If my understanding now is correct, thank God you helped me and taught me this. As up until that time I was always using the IB 'FX hedge' but that meant I was purchasing the USD currency and hence I was fully exposed to the currency risk on my principal sum. I don't know why they call it 'FX hedge' when is nothing more than converting currencies without hedging anything?!
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Old Jan 11, 2017, 9:57pm   #14
 
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Thank you for the explanation JR, I think I got it now.

So in my case, it's not like I'm going to pay the borrowed $60K with GBP funds and incur that loss at that time, I'll just pay it back when I sell the stock (directly in USD). So what you mentioned, if the stocks are still worth $60K, there would not be currency risk (just the interests paid on the loan), right?

If my understanding now is correct, thank God you helped me and taught me this. As up until that time I was always using the IB 'FX hedge' but that meant I was purchasing the USD currency and hence I was fully exposed to the currency risk on my principal sum. I don't know why they call it 'FX hedge' when is nothing more than converting currencies without hedging anything?!
Still on the hedging, besides futures you can also think of an ETF of the currency pair instead of using futures (avoiding the roll-over problem).
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Old Aug 8, 2017, 2:58am   #15
 
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If you make a profit on your stocks, let's say you sell for USD 160k... Then you wil lend up with a positive USD cash balance of 10k.... So in effect, you have currency risk on your P/L only.


JackRab, do you mean that there is no currency risk when I purchase a foreign stock on IB, except for the P/L generated later?

How can I hedge the currency risk on the P/L? What would the size of the FX be? I am thinking that it should only match the number in the unrealized P/L column, while position size and realized P/L are irrelevant. Is that correct?

For example, I am a US investor who has bought 1000 EUR of an EUR stock. Today the total unrealized P/L is 100.
In this case, I should only short 100 EUR of EUR/USD to hedge, not 1100 EUR.
If tomorrow the unrealized P/L becomes 80 (regardless wether it's because the market drops or because I have sold some position to realize a profit of 20), then I should reduce the total size of the short to 80 EUR of EUR/USD. Is that correct?

Thanks.

Last edited by Ceeyee; Aug 8, 2017 at 3:18am.
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