Yes it should
Stat arb/ relative value trades of assets in different currencies
- Thread starter TraDaToR
- Start date
Yes it should
No, he's not:
Let's say you have a USD account and you want to buy some EUR assets.
You have 11k USD in your account, which you convert into 10k EUR at the current rate of 1.10. You invest this 10k into the EUR assets (or leave it just sitting in the account in EUR).
The price of the asset remains unchanged, but EURUSD rises to 1.20, and you sell the asset and convert the EUR 10k back into USD, i.e. you now have USD12k.
You made USD1k profit on the FX movement.
If you would have gone long EURUSD, this position would also have benefited from the increase in EUR. You therefore have to go short EURUSD to hedge a long EUR asset.
Going short a EUR asset would simply require a reverse hedge (i.e. Long EURUSD)
I thought this would have been obvious...
H2O, I saw your response just before going into the long weekend and I was seriously feeling stupid until I checked some graphs and realized Tom's hedge was working prefectly... But it was just that I hadn't been precise enough. In this example I am trying to trade KW Vs EBM * EURSUD not KW Vs EBM "as is"...The correlated pair which moves in unisson is in $ on both legs...
Check a really correlated pair like NY and LIFFE cocoa converted in $ for a better example...When GBP/USD rises, C loses value almost immediately so that CC and C in $ keep the usual premium/discount without being affected by currency values...So for your leg to keep the same value in $ you need to be for example long GBPUSD ( making money ) and long C( losing money ).
I sincerely struggle with this stuff...LOL
Check a really correlated pair like NY and LIFFE cocoa converted in $ for a better example...When GBP/USD rises, C loses value almost immediately so that CC and C in $ keep the usual premium/discount without being affected by currency values...So for your leg to keep the same value in $ you need to be for example long GBPUSD ( making money ) and long C( losing money ).
I sincerely struggle with this stuff...LOL
Sorry, my bad - you're absolutely right! I skimmed back over (part of) the thread and got carried away when answering (I must have really needed that long w/e..) - Sorry for the confusion I created..
Just to reiterate: As per Tom's post, the correct currency hedge for long Kansas wheat vs short Milling wheat is to go short EUR/USD.
To explain it in a bit more detail: as I indicated in my initial reaction, I think the easiest way to look at this is to try and neutralize your currency exposure:
Entering into a FUTURES position (i.e. a forward position) is completely different than hedging a cash position (which is what I did in my second reaction). When you enter into a long futures position denominated in a foreign currency, you are committing purchase goods (or cash settle) a certain amount of foreign currency. In order to hedge this FORWARD purchase, you will have to enter into a long position of the foreign currency which will protect you against a strengthening of this currency.
(Similarly, if the foreign currency declines you will have to pay less IN THE FUTURE, which will be offset by the loss in the long currency position.)
So, assuming are entering into a long KW / short MW position and you want to be USD neutral, you would have to hedge your forward sale of the (EUR denominated) MW by selling EURUSD.
(The reverse is true if you go short KW / long MW)
Of course if you are a EUR based investor you would have to apply the same logic to hedge your USD exposure.
I hope this really helps...
Just to reiterate: As per Tom's post, the correct currency hedge for long Kansas wheat vs short Milling wheat is to go short EUR/USD.
To explain it in a bit more detail: as I indicated in my initial reaction, I think the easiest way to look at this is to try and neutralize your currency exposure:
Entering into a FUTURES position (i.e. a forward position) is completely different than hedging a cash position (which is what I did in my second reaction). When you enter into a long futures position denominated in a foreign currency, you are committing purchase goods (or cash settle) a certain amount of foreign currency. In order to hedge this FORWARD purchase, you will have to enter into a long position of the foreign currency which will protect you against a strengthening of this currency.
(Similarly, if the foreign currency declines you will have to pay less IN THE FUTURE, which will be offset by the loss in the long currency position.)
So, assuming are entering into a long KW / short MW position and you want to be USD neutral, you would have to hedge your forward sale of the (EUR denominated) MW by selling EURUSD.
(The reverse is true if you go short KW / long MW)
Of course if you are a EUR based investor you would have to apply the same logic to hedge your USD exposure.
I hope this really helps...