Hedged Carry, doable?

[mirolho]

I'm still new in forex trading, but i have some knowledge on options hedges.
So i heard about carry trades, and i thought about doing a carry trade by buying the pair and hedging it with options. For example, i could buy EURUSD(on interbank they pay $6 per day, if i understand it correcly) and buy EURUSD puts (or put on a collar or other option strategy)to hedge my position. This way, if EURUSD falls, i don`t lose money, but i still gain interest.
Im still new in forex, so i have some questions:
1. Do options positions earn interest like spot positions?
2. I dont quite understand forex options pricing. For example, if the EURUSD call costs 0,0510, then 100.000 (to cover 1 lot) would cost 5.100,00?
3. If thats the correct pricing, can i buy them with leverage? For example, with a 100:1 leverage would it cost 51,00?
4.is this kind of trade possible(doable or profitable)?

Thanks in advance

 

[Rhody Trader]

To add to GJ's answers, while options neither pay nor receive carry, I'm almost certain that the interest differential is incorporated into the pricing. If it were not, it would present an arbitrage opportunity and we all know those don't tend to exist in readily exploitable fashion for very long.

 

[mirolho]

n.b. beware here of the bid/offer spread in the money market rates at your particular broker - they can eat big chunks into your carry profit and in some more marginal cases can make what would have been a positive carry situation (based on wholesale interbank rates) flat or even negative. It's the rate DIFFERENTIAL between the two that counts, so spread is definitely a factor.

I understand i lose some in the spread. But I want to make a long term trade (i found options to june/2009). Say I buy one lot and it costs me US$1.000,00 (thousand dollars), perhaps I'll lose US$200,00 on the spread, but if my position is correcly hedged and I make US$6,00 per day, i can recover those 200 just after the first month, and then what comes after that is profit

2) I think it would help if you did three things. One - state in what terms that example price was made - there's more than one way to express an options price - common examples would be either % of EUR face amount or in USD pips. Two - state what currency your example options premium amount was expressed in (EUR or USD). Not as stupid a question as you would think, especially based on the point I made above. Three Re-express your use of commas and full stops to UK style as you risk confusing a lot of potentially helpful people on this site. I had a pretty cr@ppy nights sleep last night and remembering that in other parts of the world they use commas and full stops differently is giving me a headache

I've been testing this trade on the saxobank simulator, but i think they dont simulate rollovers, either way, i think i figured the price issue, on the saxotrader the price is stated like this: Ask 0,0510; Premium 5.100,00 USD (this is the EURUSD call, if I buy 100000). So the price is in dollars.
And I used points for thousands and commas for cents, so five thousand dollars would be 5.000,00 USD.
So 100.000(one hundred thousand options) would cost 5.100,00 USD, and i would like to know if i have to pay the full price or if i can leverage that, paying only 51,00 USD for the whole lot (assuming i have a 100:1 leverage)?

4) Yes and Yes, depending on many factors. There are some otehr relevant questions connected to that question - "Is it do-able all through one broker / one set of margin funds etc?).

As I said, i found this broker called saxobank, and they trade spot and options, so i guess i can do it with the same account.

To add to GJ's answers, while options neither pay nor receive carry, I'm almost certain that the interest differential is incorporated into the pricing. If it were not, it would present an arbitrage opportunity and we all know those don't tend to exist in readily exploitable fashion for very long.

Even if the options have an incorporated interest differential, i think it is still possible to make money buy choosing the right strategy.
For example, if I just buy spot and puts (assuming the prices I see now: 1,5520 for the spot, June/09 call 0,0510 and 0,0749 for the put, and a 100:1 leverage on options) i would spend 1.074,90 USD on the position (1 lot of EURUSD + 100000 EURUSD june/09 calls), the worst case scenario would be if the pair, by the expiration date, is at the strike price of the option or lower, in that case I will lose what I spent on the options (7.490,00 USD) minus what i get from interest (if it's 6,oo USD per day, times 365, it would make 2.190,00 USD). So i would lose 5.300,00 USD on the worst case.

But I'm thinking of buying a more complex strategy: a collar (buy a put and sell a call, both at the money). This would make the position a lot cheaper, because i get a credit when i sell the call. This way, the position would cost 1.023,90 (1.000,00 USD for the spot, 74,90 USD for the put, and a credit of 51,00 USD for the short call). The maximum risk would be the difference between the options prices (0,0239) plus the difference between the price of the spot and the strike prices (wich in this case was 0). So in this particular trade, the maximum risk would be 2.390,00 USD minus what you get from the interest, but it's also the maximum profet because the position is locked.

This was not a very good trade, but you can make different types of collars with a profit potential or choose a different pair for higher interest.

Correct me if im wrong.

Thanks for the replies.

 

[luckyd1976]

Interesting thread...
Married Puts for EUR/USD? Interesting

 

[mirolho]

I've been thinking a lot about hedged carry trades lately, and another way it would work in theory is if you buy the spot and sell a call with a strike price that you think the spot will not reach by the time of expiration. For example, i think that by next month eurusd will not be worth 1,3000, so i buy eurusd and sell a august 2008 1,3000 call. This way i keep a little premium AND i get the interest.
And, on the plus side, what i get from selling the call will lower my initial investment, specially if i choose one with a very low strike price (but i get lower premium).

I said this would work on theory, but i doesnt work in practice, why?
Because i found out that calls with very low strike prices have negative premium!!
For example, if the spot is at 1,5000, and the call has the strike price as 1,2000, it will be worth less than 0,3000, and that difference kills the interest you would win from the rollovers.
However, this negative premium thing only happens because we are talking about european options, so i would like to know if there is any forex broker out there that uses american options on forex?


anyway, even if there arent any american options out there, i figured out a way to take advantage from the negative premium. I already posted it in this forum, but on the options section. Its a very low risk strategy, in theory at least, with a pretty decent return (around 200% in a one year period), but i would like to see people comment on it and try to figure out why this trade wouldnt work on a live account (i believe it would work)
Here is the link to the other post:
http://www.trade2win.com/boards/options/34618-amazingly-low-risk-spread.html

 

[MrGecko]

Options on currencies are discounted for the interest differential, just like dividends are for stocks. As RT said, this would lead to Arb. opportunities otherwise.

 

[Rhody Trader]

I've been thinking a lot about hedged carry trades lately, and another way it would work in theory is if you buy the spot and sell a call with a strike price that you think the spot will not reach by the time of expiration.

This isn't really a hedge. This is covered call writing. It's been used in the stock market for many, many years as a "yield enhancement strategy". It's a one way profit profile. Your upside is limited because of the call you've sold, but you're downside is wide open.

 

[mirolho]

This isn't really a hedge. This is covered call writing. It's been used in the stock market for many, many years as a "yield enhancement strategy". It's a one way profit profile. Your upside is limited because of the call you've sold, but you're downside is wide open.

yes, the downside is open, thats why you choose a strike price that you are almost sure that the spot will never reach. This way you get very little premium, but you get the interest, wich is what you wanted all along

 

[Rhody Trader]

yes, the downside is open, thats why you choose a strike price that you are almost sure that the spot will never reach. This way you get very little premium, but you get the interest, wich is what you wanted all along

And if the market goes against you there's almost zero protection.

 

[mirolho]

And if the market goes against you there almost zero protection.

you only lose protection if the spot price goes below the strike price, so you choose an option with a very low strike price.
For example, if I buy eurusd and sell a call with the strike price of 0,2000. I will lose money only IF, by the time of expiration, the spot is below 0,2000 (its at about 1,5700 right now).
I know there is a possibility of that to happen, but i am willing to take that risk, cause on the charts i have here for eurusd (since 84) there wasnt a down move even close to what would be necessary to make me lose money on this particular position.
Anyway, if the spot gets anywhere near the 0,2000 i can just stop out my position and wont lose much.

But, as i said earlier, this doesnt work because, at forex, the lower strike options have prices below it implied values and an inverse time decay. But that wouldnt happen with american options. Thats why i asked if there were any out there.

And besides, what i really wanted is for you people to comment on my other thread (that i just posted the link to), wich is a way to use the invese time decay on my favor.

 

[mirolho]

i found a way to make it possible to do a completelly hedged carry trade.

Puts that are very in the money are very cheap, so you can buy the spot and a put for a low price.
This way you have a completelly hedged carry trade.