Log in Open account
Switzerland
Leveraged products (e.g., CFDs, Forex (FX) including crypto/fiat, options) are complex instruments and come with a high risk of losing money rapidly due to leverage. 61% of retail investor accounts lose money when trading CFDs with this provider. 0.90% of retail clients trading in leveraged products experience a negative account balance after a stop-out occurred. 
Show more
Leveraged products (e.g., CFDs, Forex (FX) including crypto/fiat, options) are complex instruments and come with a high risk of losing money rapidly due to leverage. 61% of retail investor accounts lose money when trading CFDs with this provider. 0.90% of retail clients trading in leveraged products experience a negative account balance after a stop-out occurred. You should consider whether you understand how CFDs, FX, or any of our other products work and whether you can afford to take the high risk of losing your money.
Show less
Investing with (FX) options: Hedging USD portfolios against USDJPY currency risk

Investing with (FX) options: Hedging USD portfolios against USDJPY currency risk

Options 10 minutes to read
Koen Hoorelbeke

Investment and Options Strategist

Summary:  This article explores the use of FX options as a hedge against currency risk in USD-denominated portfolios, focusing on the effects of a declining USDJPY rate. It presents a detailed example to demonstrate how investors can shield their investments from adverse currency movements, offering clear insights into managing currency fluctuations and the benefits of strategic hedging.

Hedging USD portfolios against USDJPY currency risk

Introduction

For investors with significant holdings in USD-denominated assets, the challenge of currency fluctuations, especially when the USDJPY rate declines, is a key concern. Safeguarding the value of these investments from such fluctuations is crucial. This article demonstrates the effective use of FX options as a hedge against this specific currency risk, focusing on the mechanics and outcomes of using these financial instruments to protect a USD-heavy portfolio.

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.

 

Initial Position

  • Investment/portfolio: A Japanese investor converts ¥14,780,000 into USD for investing in the US stock market (or has already existing holdings in USD with a value of $100,000.-).
  • Exchange rate: The current USDJPY rate is 147.8, so the investor gets, or value corresponds to $100,000 (¥14,780,000 / ¥147.8).

Impact of Currency Fluctuations

  1. Japanese yen strengthens (USDJPY rate decreases to 135, for instance)

    • Effect on investment: If the investor's USD holdings remain at $100,000, converting back to JPY at this rate would result in ¥13,500,000 ($100,000 * ¥135). This is a loss compared to the initial investment in JPY.
    • Outcome: The investor incurs a loss in JPY terms due to the strengthening of the JPY
       

  2. USD Strengthens (USDJPY Rate Increases)

    • Example: If the exchange rate changes from ¥147.8 to ¥155, for instance.
    • Effect on investment: Converting $100,000 back to JPY at this rate would yield ¥15,500,000 ($100,000 * ¥155), more than the initial investment.
    • Outcome: The investor gains in JPY terms due to the weakening of the JPY.

Complete Portfolio Hedging Example with FX Options

Context:

  • Portfolio value to hedge: $100,000
  • Objective: Hedge against the risk of USDJPY declining to 135.

FX Option Details:

  • Current USDJPY Exchange Rate: 147.8
  • Anticipated risk scenario: USDJPY declines to 135.
  • Alternate scenario: USDJPY appreciates or remains unchanged.
  • Put option specifics:
    • Strike price: 147 JPY per USD
    • Option premium: 5.566 JPY per USD
    • Nominal value of option: $100,000
    • Expiration date: 25th July 2024 (6 months from now)
    • Total premium paid: 556,600 JPY

Hedging strategy execution:

  • Action: Purchase put option(s) on USDJPY with a total premium cost of 556,600 JPY to cover $100,000.

Scenarios and financial outcomes:

  • Scenario - USDJPY declines to 135:
    • Without hedging: The $100,000 portfolio converts to ¥13,500,000 at this rate, resulting in a significant loss due to currency fluctuation.
    • With hedging: Exercise the put options to sell $100,000 at the strike rate of 147, achieving ¥14,700,000. The net gain from hedging, after the premium, is ¥643,400 (calculated as the profit from the option exercise of ¥1,200,000, which is ¥14,700,000 - ¥13,500,000, minus the premium paid of ¥556,600, resulting in ¥643,400).
  • Scenario - USDJPY appreciates or remains unchanged:
    • Portfolio value: The value of the USD portfolio in JPY terms increases or remains stable.
    • Put option(s): These options expire worthless.
    • Financial outcome: The loss is confined to the premium paid for the options, totaling 556,600 JPY.

Suggestions? Ideas? Let us know!

Conclusion

Effectiveness of hedging: If USDJPY declines to 135, the strategy significantly reduces the currency risk. The net loss after hedging is ¥636,600, far lower than the ¥1,280,000 loss that would occur without hedging.

Cost of hedging: If the USDJPY does not decline, the cost of the hedge is limited to the premium paid, which is 556,600 JPY. 

Overall financial outcome: This example shows the potential results of using FX options for currency risk hedging. It emphasizes the importance of balancing potential loss reductions against the costs in less favorable or stable market conditions. While this article focuses on a basic hedging approach, more advanced strategies could optimize the hedge further, but exploring these is beyond its scope.
For continuous insights and updates on market/options strategies, interact with me/follow my social media account on Threads.

 Feedback? Ideas? Suggestions? Let us know.

Listen to our brand new podcast: "Saxo Options Talk"

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 /

  • 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
  • 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
  • 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

 The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research 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. To the extent that any content is construed as investment research, you must note and accept that the 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 under relevant laws.

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

Saxo Bank (Schweiz) AG
The Circle 38
CH-8058
Zürich-Flughafen
Switzerland

Contact Saxo

Select region

Switzerland
Switzerland
Products & pricing
Platforms
Accounts & service
General
Other
Legal

Losses can exceed deposits on margin products. Please ensure you consult our Risk Warning before you start trading and you understand the risks.

All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved we have put together a general Risk Warning series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) Ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law. 

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.