Personal - Currency Hedge

Wonder if anyone here might have some guidance for me as I'm a novice around currency hedging and wonder if it might be a smart thing for me to look into or should it be left to the preserve of sophisticated investors

Currently have $500,000 in cash and living in the USA. However this is temporary and I consider my functional long term currency to be Euro and anticipate a return to Ireland in early 2018.

We have remained in dollars in anticipation of its continued strength against the Euro. Most commentators pointing towards EUR/USD parity by mid-2016 - it did indeed briefly touch 1.05 in Dec 2015 (we perhaps should have converted at this point) but as you may have seen the dollar has weakened against the Euro (reaching 1.13) as further FED rate hikes are seen as less likely.

However FX analysts still point towards $ strength against the Euro in the medium term indicating rates of 1.02 - 1.04, even parity as still likely once US / EU central bank policy divergence continues. I fear however that 1.05 of 2015 won't be seen again and we might see a return to historical average of c1.30. Each 1cent move increasing or decreasing my EUR position by c.4000euro - painful!. You could argue that since Dec 2015 to the 1.13 peak last week I "lost" 32,000 in terms of my EUR holdings (move from 1.05 to 1.13). It has since drifted back to 1.09 as of Friday.

Given the current market volatility I'd like to protect myself against the possibility of further dollar depreciation. Locking in a rate of 1.09 (current rate) and creating a scenario where my downside risks are capped going forward but where I can still benefit if EUR/USD changes move in my favor would be great. Effectively insurance for which there will obviously be a premium paid.

Ive seen from previous threads that folks have used spread betting to hedge their sterling exposure. Do you think this could provide a solution for me or would FX options be more appropriate strategy. Any idea of the premium I might pay per month to hedge my exposure - would the cost of hedging be justifiable for the amount I'm talking about?

About 3% per annum would be the financing charge for a spread bet which on 500000 would be 15000.

As far as I know spread betting is illegal for American citizens though.

Why don't you just transfer the money and not bother gambling (which is what you are essentially doing)? No downside that way.

FX analysts haven't a notion what way fx rates will go (and neither do you or I) iignore their BS

Username2012 said:

Why don't you just transfer the money and not bother gambling (which is what you are essentially doing)? No downside that way.

FX analysts haven't a notion what way fx rates will go (and neither do you or I) iignore their BS

Click to expand...

Agree that FX is notoriously hard to predict but to be fair I could have taken the above attitude 2 years ago and transferred at 1.38 (which would have been a mistake as it sits at 1.09 today) but ultimately the consensus was very clear on the strengthening of the dollar and holding was the right thing to do

A fairly similar consensus / sentiment exists now, albeit less bullish, on continued dollar strength. The average 6 month to 12 month forecast has the EUR:USD at 1 or 1.02 (some even as low 0.98) which is fairly consistent across FX strategists. Hence my desire to hedge the downside risk (if reasonably priced) and perhaps gain on the upside.

In the example above where EUR/USD drops to parity (from 1.09) my Euro holdings could increase by 36,000 ( 9cent move x 4000euro per cent).

Anyone any idea how much an FX Option for 500k @ 1.09 dated for say 06/2017 would be? Cheaper or more expensive than a spread bet?

Options would be easy and tons of volume, just call up your bank's FX desk and they should quote you on $500k cash options;

Of course you could buy the options yourself against the EUR/USD futures; each futures contract is for $125k so four lots would give you a very accurate match.

You could buy a 1.10 Call on four lots with a DEC16 expiry.

Alternatively, based on your post, an alternative to just buying the calls to protect you against a EUR rally, you could actually sell four PUTS below the current market;
So, say you sold a 1.05 PUT for DEC16 expiry, this would essentially guarantee that your 500k would be converted at 1.05 if EURUSD is trading below that level come DEC16; selling these PUTS will generate income for you which you keep, regardless of price action. The downside to selling the puts is that that income you generate on selling them is all that you can make, there's no more profit, so if the EURUSD rallies to 1.20 the only hedge you have is the income from selling the puts.
Thus, and hopefully this is all still reasonably clear, you could sell four puts down at 1.05 and use that income to buy four lots of 1.15 calls -- this should be close to netting out your costs though I'd have to check the prices, meaning you should have a pretty cheap hedge.

Any reasonable FX broker could do this for you and it really shouldn't be too expensive at all.

EDIT:
Just to add; indicative pricing; market quiet at the moment so only looking out to MAY16 expiry:
If you sold four 1.05 puts you'd make 40 ticks per contract, which is $12.50 * 4 contracts * 40 ticks = $2,000 (you keep that no matter what, but you commit to change your Dollars at 1.05 if the market hits there before MAY 6th);

You could use that $2,000 to buy four lots of 1.16 calls; thus hedging you entirely from 1.16 and higher between now and May 6th

There are very few currency funds available. They ones that you can buy into are very expensive. The reason? It's VERY hard to trade currencies well and those few that do it have loads of resources. Even then, they get it wrong a lot of the time. You are making a one time bet that you are going to make money on the way two currencies are going to go. You'd want to be getting good returns for that high risk bet.


Steven
http://www.bluewaterfp.ie (www.bluewaterfp.ie)

with the market open: a SEPTEMBER 1.10 CALL is about 400 ticks, so you'd need four lots which is $20k to hedge your $500k from 1.10 upwards until September 9th 2016;
implication there is that you'd need to see spot below 1.06 in September to make it worth your while having paid for the calls.