Log in Open account
Singapore
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 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 is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, 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 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 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 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 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 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.

Trading in financial instruments carries risk, and may not be suitable for you. Past performance is not indicative of future performance. Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo 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 Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

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

Losses can exceed deposits on margin products. Please ensure you understand the risks.

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning 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. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

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

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 are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.