Currency hedge

OK, I can't believe I'm asking this but I've fried my brain this PM and now cant solve the simplest of things.

If I'm short 2 contracts on the ER2, equivalant to about $140,000 dollars, and I want to protect against currency risk as it's a long term trade.

Do I hedge the full £140K with a down bet on the £/$ , or the margin portion.

It's the full $140K I need to hedge (hence about £7 per pt ish down bet on Cable).....right?

Cheers,
UTB

the blades said:

It's the full $140K I need to hedge (hence about £7 per pt ish down bet on Cable).....right?

Cheers,
UTB

Click to expand...

Yes, that's right.

UTB,

Hello, mate. How’s it going?

I may be mistaken but I question the validity of this hedge. Your now exposed on two fronts: rising ER2, rising cable.

Further, your proposed hedge assumes total point-for-point exposure with 100% of the ER2, ie its total value. Surely this is incorrect – your exposure is the difference between your opening value and your closing value.

I wouldn’t bother hedging; your greatest risk is on the ER2 upside, not currency (which is relatively minor). However, if you insist, maybe consider a long put on cable – limited risk.

Grant.

grantx said:

UTB,

Hello, mate. How’s it going?

I may be mistaken but I question the validity of this hedge. Your now exposed on two fronts: rising ER2, rising cable.

Further, your proposed hedge assumes total point-for-point exposure with 100% of the ER2, ie its total value. Surely this is incorrect – your exposure is the difference between your opening value and your closing value.

I wouldn’t bother hedging; your greatest risk is on the ER2 upside, not currency (which is relatively minor). However, if you insist, maybe consider a long put on cable – limited risk.

Grant.

Click to expand...

Eyup Grant,

It was going well until we got stuffed by the pigs this weekend! How are you?

My misery has been further compounded by the most basic of erros - ie ***king up my hedges.

The Short ER2 contracts are actually hedging an equivalent sized portfolio of stocks (remember that old thread, eh?), so the risk of market direction is practically zero.

In opening the ER2 contracts, I cancelled my spereadbet on the russell (in £'s / pt), but kept open my currency bet that was covering my $ stock portfolio. So I was now exposed to a drop in cable.

You say it's not that big a risk, but it's fallen 5% over the last month and that's hurt

If I hold the contracts for 3 months an there's no change to the index value, but the £ halves in value (not realistic, but for example), it will cost me twice as much to buy back the contracts when I want to close....wont it?

As for your suggetsion to buy a put - look how simple this problem is, and I can't solve it (well, I hope I have). What chance have I got with options:cheesy:

I welcome all repsonses as I've got a horrible feeling I'm still missing the obvious.

UTB

UTB,

What tangled webs we weave. We all make the basic error of ***king of something or other.

I think this is your position at the moment:

Short 2 x ER2
long an equivalent sized portfolio
short GBP/USD.

So your exposure is cable. “fallen 5% over the last month and that's hurt” Your set-aside cheque will cover that. From a fundamental perspective, given the US/UK interest rate differential and the looser policy of the Fed (more Fed rate cuts vs fewer and to a lesser degree by the BOE) I would suggest cable will strengthen. This should help (if it weakens, it won’t help).

Perhaps the choice is, hold and hope for an increase; hold but use a stop to halt further deterioration.

Grant.

Wow that is a complicated one! fwiw I work as a portfolio manager at a fund management firm, so these are the sort of issues I have to worry about on a day to day basis, but fortunately I have systems to tell me exactly what my currency exposure is!

A couple of points:
1) As Grantx says the ER2 futures will only generate USD exposure to extent of any unrealised P&L i.e. variation margin
2) As far as the stock portfolio is concerned the important point is how you are funding the position. If you are funding the position through a negative USD cash position (i.e. a loan), then the stock and cash positions offset each other, and the only USD exposure will be the difference between the two. If, on the other hand, you physically had to transfer GBP cash into USD to buy the stocks then you have long USD exposure equal to the market value of the stocks.

In other words, assuming you did transfer money from GBP into USD to purchase your stocks then, your position:

Long US stocks
Short ER2 futures
Long GBP vs USD (USD amount equivalent to the stock portfolio value)

should be currency neutral overall. Your loss on your FX hedge as cable sold off should be exactly offset by an FX gain on your stock holdings (i.e. they should now be worth more in GBP terms)

(of course if your stock position is funded through a negative USD cash position you will have a net short USD position)

Hope that makes sense...

Max

Max,

The plot thickens.

I presume you'd pass this to one of your bright, young assistants: "Sort this out, mate, I'm busy. And be quick about it."

Grant.