Managing FX Exposure Transaction Exposure – FX Options.

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Presentation transcript:

Managing FX Exposure Transaction Exposure – FX Options

Managing TE – Hedging with FX Options Review: Reading Newspaper Quotes PHILADELPHIA OPTIONS(PHLX is the exchange) Wednesday, March 21, 2007(Trading Date) CallsPuts=>(Contracts traded) Vol.LastVol.Last=>(Vol.=Volume, Last=Premium Australian Dollar79.92=>(S t =.7992 USD/AUD) 50,000 Australian Dollars-cents per unit.=>(AUD 50,000=Size, prices in 78June USD cents) 79April May June June ↑↑ ↑ ↑ X=StrikeT=MaturityCall PremiumPut Premium Price

Receivables in FC Example : Receivables AUD 20M OTM: X put-June = 0.78 USD/AUD Cost = Total premium = AUD 20M * USD.0149/AUD = USD 298K Floor =0.78 USD/AUD x AUD 20M= USD 15.6M (Net: USD M) ITM: X put-June = 0.82 USD/AUD, (or X put-June =.80 USD/AUD –ATM) X put-June = 0.82 USD/AUD Cost = Total premium = AUD 20M * USD.0361/AUD = USD 722K Floor =0.82 USD/AUD * AUD 20M= USD 16.4M (Net: USD M) X put-June = 0.80 USD/AUD (ATM option) Cost = Total premium = USD 504K Floor = USD 16M (Net: USD M) Note: The higher the cost, the higher the floor for the AUD 20M. ¶

All the FX options limit FX risk: - X put-June = 0.78 USD/AUD => Net floor: USD M - X put-June = 0.80 USD/AUD => Net floor: USD M - X put-June = 0.82 USD/AUD => Net floor: USD M Q: Which one is better? It depends on your preferences and expectations USD M X put =0.82USD/AUD Net Amount Received in June S June (USD/AUD) USD M X put =0.78 USD/AUD USD/AUD => break even S June

Payables in FC Example: Payable AUD 100M in Mid-June S t =.7992 USD/AUD X call-June =.78 USD/AUD, P = USD.0337 X put-June =.78 USD/AUD, P = USD.0149 X call-June =.80 USD/AUD. P = USD.0229 X put-June =.80 USD/AUD. P = USD.0252 X call-June =.82 USD/AUD, P = USD.0138 X put-June =.82 USD/AUD. P = USD.0361 OTM: X call-June = 0.82 USD/AUD (or X call-June =.80 USD/AUD, almost ATM) X call-June = 0.82 USD/AUD, Premium = USD.0138 Cost = Total premium = AUD 100M * USD.0138/AUD = USD 1.38M Cap = AUD 100M x 0.82 USD/AUD = USD 82M (Net: USD 83.38M)

X call-June = 0.80 USD/AUD, Premium = USD.0229 (almost ATM) Cost = Total premium = AUD 100M * USD.0229/AUD = USD 2.29M Cap = AUD 100M x 0.82 USD/AUD = USD 80M (Net: USD 82.29M) ITM: X call-June = 0.78 USD/AUD, Premium = USD.0337 Cost = Total premium = USD 3.37M Cap = USD 78M (Net cap = USD 81.37M) Note: The higher the cost, the lower the cap established for the AUD 100M. ¶

Lesson from these 2 examples: 1) Options offer the typical insurance trade-off: Better coverage (lower cap, higher floor) => Higher cost (higher premium) 2) Insurance is expensive. For the X put-June = 0.80 USD/AUD case, it costs USD.504M to insure USD M (a 3.2% premium). Q: Is it possible to lower the cost of insurance lower? A: With a Collar (buy put, sell call/buy call, sell put). Example: Buy X put-June = 0.78 USD/AUD (P = USD.0149) Sell X call-June =.82 USD/AUD (P = USD.0138) Cost = USD.0149 x (20M) – USD.0138 x (20M) = 22K (very low!) Floor = USD 15.6M (Net Floor = USD M) Cap = USD 16.4M (Net Cap = Best case scenario = USD M) A collar is cheaper, but it limits the upside of the option. ¶