Currency Options Explained
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The change could reflect more conservative counterparty risk management and the application of credit value adjustment CVA. Overall, from December to June FX options volumes increased by This could reflect the lower volatility experienced over the period that trading otc currency option hedging strategy the purchase of options cheaper, or an increased appetite for trading non-linear products.
By suggesting potential advanced hedging strategies, this article aims to demonstrate a cost-effective way for corporate treasurers to mitigate FX risks. This business case will examine various advanced FX hedging strategies, and their impact had Google deployed them within this time period.
It commences with single asset strategies such as average rate options, partial barrier forward, compound options and gated knock out. Finally, it examines the multi-asset strategies of cross-asset knock out and a basket option. The results, in millions of dollars, are shown in Figure 3, derived from the financial reports of Google in December This section suggests the different hedging strategies that may be used by Google to address its FX exposures. Any prudent treasurer aims to mitigate currency risk on an on-going basis.
For Google, given its reported exposure to the weakening euro, there is an immediate requirement to hedge euro receivables. The group has the following options for hedging:. The fixing source has to be agreed upon inception examples: This strategy is composed of the following two options: The sold option would only be activated if the market trades at 1.
Using this option, the buyer holds a compound option at a strike price of 1. Google is to participate in a tender in euro trading otc currency option hedging strategy. In this particular case, the company wishes to hedge an uncertain FX risk that would persist only if it wins the tender. As in the previous use case, its receivables would be dominated in euros and an underlying exposure would be generated. If it loses the tender, there would be no FX risk.
So Google wishes to hedge this potential FX exposure at minimal cost. Instead of buying a vanilla option, the company would be buying a compound option. As an trading otc currency option hedging strategy, if in three months precisely the market trades at 1. If the market trades below 1. However, if at expiry the market trades above 1. This section considers the usage of two multi-asset strategies: As this is a multi-underlying assets structure, it is necessary to observe the correlation of these two underlying assets; estimated at 0.
If the market trades above 1. This article has discussed various hedging strategies: The cost of the options varies; in all cases but one compound option, when exercised the suggested strategies cost less than an equivalent trading otc currency option hedging strategy option.
Each option has a unique profile that could be used in an adequate use case exposure according to the hedging policy of the firm. In hindsight, the most effective strategy would have been entering a partial barrier at a zero cost.
The reason being that the sold option-partial barrier call euro option would have lapsed and Google would have been long a vanilla put euro option, struck 1. Figure 4 summarises the strategies suggested, as well as a target redemption forward for reference.
The unprecedented levels of volatility experienced over the past two years, coupled with the high level of uncertainty, have trading otc currency option hedging strategy drivers for adopting a prudent approach to managing FX exposures.
When deciding and implementing a hedging programme one must take into account the historical and projected underlying prices fluctuations, examine and select the most suitable hedging strategies, as well as running the selected programme through various potential market scenarios and determine its efficiency. Decision support systems to assist with managing the hedging process are readily available.
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