FX Hedge Through Options

L

lightrader

Hi, I posted a question regarding the best way to hedge GBP/USD exposure through options in the options forums but I didn't get answers (regarding options) so I posted also here.

My problem is that I want to buy a GBP stock and I want to hedge against GBP fluctuations vs. USD by using options. In the options forum there were suggestions that I just sell futures, but I prefer to find a solution through options and not through futures.

I thought about buying out of the money put on the GBP/USD futures or on the XDB and selling out of the money call to create a collar that will narrow the spectrum of the exchange rates to which I will be exposed. I know it will not be a perfect hedge but I don't search for a perfect hedge. I search for a hedge against substantial changes in the GBP/USD exchange rate.

I would appreciate if you can state if this solution sounds reasonable to you or if there are any other possible solutions by using options. Thanks.
 
I assume you want the best answer possible? Would you be content with anyone saying "xyz is the best hedge but I dont want to say why?" If you cannot explain why you insist on a hedge via options then please do not expect others to give you the best advice. Just my two cents regarding attitude.

About your question, the best hedge is a simple cash fx position, nothing else. I have no idea why you want to pay time value if you can completely eliminate fx risk through a simple cash fx trade.

You take exposure to a UK stock and worry about fx exposure yet you want to load up on a whole lot of greeks that you seem to have no interest in exposing yourself to. Makes zero sense to me...
 
You primary concern should be the risk on the shares. Probably less anxiety to simply trade shares in your base currency. Sell the risk-reversal or sell the same-strike synthetic to effect a delta1 trade. Cheaper still -- sell some fraction of your GBP in a long USDGBP spot trade at 50x. It seems like you want to be talked into something. You obviously know what needs to be done... so are you looking for an excuse to build some gamma in the FX hedge? If so, then admit you want to make two bets; one in long shares and one in short GBP.
 
Quote from atticus:

You primary concern should be the risk on the shares. Probably less anxiety to simply trade shares in your base currency. Sell the risk-reversal or sell the same-strike synthetic to effect a delta1 trade. Cheaper still -- sell some fraction of your GBP in a long USDGBP spot trade at 50x. It seems like you want to be talked into something. You obviously know what needs to be done... so are you looking for an excuse to build some gamma in the FX hedge? If so, then admit you want to make two bets; one in long shares and one in short GBP.
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First of all thanks for the comments. I really appreciate your help.

I don't want to be talked into something, I just wondered if buying OTM put and selling OTM call for a zero premium might be a better position then just selling futures, since I will have a limited upside and downside GBP/USD exposure and as long as the GBP/USD don't go completely out of this range I will be in the same position as I had with just long the stock. I prefer to avoid the futures (or selling cash) mainly due to the resulted MTM profits/losses, constantly changing margin requirements, etc. I just feel more comfortable with a hedge that will start working only in certain circumstances. If you think that my logic is not correct in this regard I would be happy to hear why.

By the way, what do you mean by selling risk-reversal? Also, if I understand correctly, selling same-strike synthetic is equal to selling futures, isn't it?
 
Quote from lightrader:

First of all thanks for the comments. I really appreciate your help.

I don't want to be talked into something, I just wondered if buying OTM put and selling OTM call for a zero premium might be a better position then just selling futures, since I will have a limited upside and downside GBP/USD exposure and as long as the GBP/USD don't go completely out of this range I will be in the same position as I had with just long the stock. I prefer to avoid the futures (or selling cash) mainly due to the resulted MTM profits/losses, constantly changing margin requirements, etc. I just feel more comfortable with a hedge that will start working only in certain circumstances. If you think that my logic is not correct in this regard I would be happy to hear why.

By the way, what do you mean by selling risk-reversal? Also, if I understand correctly, selling same-strike synthetic is equal to selling futures, isn't it?
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It's not a collar unless you're in the underlying. Selling(buying) the OTM call(put) is a risk-reversal. It's a suitable hedge at zero-outlay and the haircut is low.
 
Quote from atticus:

It's not a collar unless you're in the underlying. Selling(buying) the OTM call(put) is a risk-reversal. It's a suitable hedge at zero-outlay and the haircut is low.
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If I long the stock which is denominated in GBP doesn't that mean that I actually long GBP (the underlying) through the stock? If not, isn't there any way to create a "real" collar in such situation? Of course I would prefer to have a "real" collar in which my upside and downside are limited, and not a risk-reversal in which the stock can go down and the GBP/USD can go up and I will lose money regarding both sides, but I am not sure if this is possible in such situation...

Also, selling same-strike synthetic, as you suggested, is equal to selling futures, isn't it?
 
Quote from lightrader:

If I long the stock which is denominated in GBP doesn't that mean that I actually long GBP (the underlying) through the stock? If not, isn't there any way to create a "real" collar in such situation? Of course I would prefer to have a "real" collar in which my upside and downside are limited, and not a risk-reversal in which the stock can go down and the GBP/USD can go up and I will lose money regarding both sides, but I am not sure if this is possible in such situation...

Also, selling same-strike synthetic, as you suggested, is equal to selling futures, isn't it?
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I am referring to a bear R/R on the GBP; specifically a long OTM call, short OTM put on USDGBP, in futures, spot (OTC) or ETFs. Ostensibly you would be long shares in GBP base currency -> the aforementioned FX bull reversal on USDGBP.

Yes, same-strike is = futures or spot. It's obviously the most direct short (USD long).
 
Quote from atticus:

I am referring to a bear R/R on the GBP; specifically a long OTM call, short OTM put on USDGBP, in futures, spot (OTC) or ETFs. Ostensibly you would be long shares in GBP base currency -> the aforementioned FX bull reversal on USDGBP.

Yes, same-strike is = futures or spot. It's obviously the most direct short (USD long).
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Assuming that the available exchange-traded instruments are on the GBP/USD underlying (and not USD/GBP) I assume that the R/R would be a short OTM call and a long OTM put -- please correct me if I am wrong.

Can you please state what are the most liquid exchange-traded products on the GBP/USD (or USD/GBP)? I found only the XDB (PHLX) and the futures options on the GBP/USD futures (Globex) but the volume of both of them seems to be relatively low, and since it is such an important exchange rate I thought there should be more liquid products.

Again, thanks for your time and responses. I am sorry for asking so many questions but you really helps me.
 
Quote from lightrader:

Assuming that the available exchange-traded instruments are on the GBP/USD underlying (and not USD/GBP) I assume that the R/R would be a short OTM call and a long OTM put -- please correct me if I am wrong.

Can you please state what are the most liquid exchange-traded products on the GBP/USD (or USD/GBP)? I found only the XDB (PHLX) and the futures options on the GBP/USD futures (Globex) but the volume of both of them seems to be relatively low, and since it is such an important exchange rate I thought there should be more liquid products.

Again, thanks for your time and responses. I am sorry for asking so many questions but you really helps me.
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You are correct, but the CME defies convention with GBPUSD and JPYUSD futures. FXB is the most liquid "Cable" ETF (USD numerator) and the options have some volume. You would sell the OTM put and buy the OTM call on FXB.
 
and how is all that better than just shorting GBP/USD dollar for dollar the amount you have invested in the UK stock?

GBP goes up but stock goes down but proceeds from losing stock trade buys more USD

USD goes up and stock goes down, forex profits offset stock loss

GBP goes up and stock goes up, well yeah, duh, you might as well just bought GBP

stock goes down forex goes nowhere, oh well, you just bought a bad stock

stock goes up forex goes nowhere, oh well, you just bought a good stock

and no time decay, you can hold till the cows come home.

worried about margin? Just trade a little smaller
 
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