Log in Open account
Australia
Investing with (FX) options: Hedging currency risk in USD-denominated portfolios using FX options

Investing with (FX) options: Hedging currency risk in USD-denominated portfolios using FX options

Options 10 minutes to read
Koen Hoorelbeke

Investment and Options Strategist

Summary:  In this insightful article, we explore the effective use of FX options as a strategy to hedge currency risk in USD-denominated portfolios. With a focus on the implications of a strengthening Euro against the Dollar, we provide a detailed example that demonstrates how investors can protect the value of their investments from adverse currency movements. It caters to both seasoned and novice investors, offering a clear understanding of how currency fluctuations can impact investment portfolios and how strategic hedging can mitigate these risks.

Hedging Currency Risk in USD-Denominated Portfolios Using FX Options


Introduction


Investors with portfolios largely consisting of USD-denominated stocks often face the risk of currency fluctuations, particularly the impact of a rising Euro against the Dollar. Protecting the portfolio's value from these fluctuations is a significant concern. This article presents a clear example of how FX options can be used as a hedge against such currency risks. It offers an objective look at the mechanics and outcomes of using FX options to maintain the value of a USD-heavy portfolio when the Euro appreciates.

Important note: the strategies and examples provided in this article are purely for educational purposes. They are intended to assist in shaping your thought process and should not be replicated or implemented without careful consideration. Every investor or trader must conduct their own due diligence and take into account their unique financial situation, risk tolerance, and investment objectives before making any decisions. Remember, investing in the stock market carries risk, and it's crucial to make informed decisions.

 

Complete Portfolio Hedging Example with FX Options

Context:

  • Portfolio value to hedge: $100,000
  • Objective: Hedge against the risk of the Euro appreciating to 1.15 against the Dollar.

FX Option Details:

  • Current EUR/USD exchange rate: 1.0912
  • Anticipated risk scenario: Euro appreciates to 1.15.
  • Alternate scenario: Euro depreciates or remains unchanged.
  • Call option specifics:
    • Strike price: 1.11
    • Option premium: 0.01455 per euro
    • Nominal value of option: €100,000
    • Expiration date: 19 June 2024 (166 days from now)
    • Total premium paid: $1,455.00 (€1,379.00)

Hedging Strategy Execution:

  1. Purchasing the options: Buy call option(s) on EUR/USD with a total premium cost of $1,455.00 to cover €100,000.

  2. Scenario - Euro appreciates to 1.15:
    • Without hedging: The $100,000 portfolio would be worth $100,000 / 1.15 = €86,956.52 in euros, a loss due to currency fluctuation.
    • With hedging: Exercise the call options to buy €100,000 at the strike rate of 1.11, costing $111,000. When converting this amount back at 1.15, it's worth $115,000.
  3. Scenario - Euro depreciates or remains unchanged:
    • Portfolio value: The value of your USD-denominated portfolio in euros increases or remains stable.
    • Call options: The options expire worthless.
    • Financial outcome: The loss is limited to the premium paid for the options, which is $1,455.00.
  4. Net gain and adjusting for premium (if Euro appreciates):
    • Net gain from hedging: $4,000 (from $115,000 - $111,000).
    • Adjusting for premium paid: The net gain reduced by the premium paid is $2,545.00 ($4,000 - $1,455.00).
    • Net gain in euros: Converting the adjusted net gain to euros at the rate of 1.15, we have approximately €2,213.04.

Suggestions? Ideas? Let us know!

 

Conclusion

Effectiveness of hedging: If the euro appreciates to 1.15, the strategy effectively mitigates the currency risk with a net gain of approximately €2,213.04, even after the cost of the premium.

Cost of hedging: If the euro does not appreciate, the cost of the hedge is the premium paid ($1,455.00), which is the maximum loss in this scenario.

Overall financial outcome: This example demonstrates the potential outcomes of using FX options for currency risk hedging. It highlights the need to consider both potential gains in favorable market movements and the costs in less favorable scenarios.
Feedback? Ideas? Suggestions? Let us know.

Related articles:

Previous "What are your options" articles: 

Previous "Investing with options" articles: 

 

Options are complex, high-risk products and require knowledge, investment experience and, in many applications, high risk acceptance. We recommend that before you invest in options, you inform yourself well about the operation and risks. In Saxo Bank's Terms of Use you will find more information on this in the Important Information Options, Futures, Margin and Deficit Procedure. You can also consult the Essential Information Document of the option you want to invest in on Saxo Bank's website.

This article may or may not have been enriched with the support of advanced AI technology, including OpenAI's ChatGPT and/or other similar platforms. The initial setup, research and final proofing are done by the author.

Quarterly Outlook

01 /

  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
    Read full article
  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

    Read full article
  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
    Read full article
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
    Read full article
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

    Read full article
  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
    Read full article
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
    Read full article
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
    Read full article
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
    Read full article
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...
    Read full article
Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia
Products & pricing
Asset Management
    Platforms
    Accounts & service
    General
    Other
    Legal

    Trading can result in losses. Please ensure you understand the risks.

    The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

    Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

    Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

    Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

    The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

    Please click here to view our full disclaimer.