Hedging non USD base currency accounts?

[gf58 771]

A quick question for those who have non-USD base currency accounts, do you normally hedge your SO holdings? If so what methods are you using?

 

I've been by account balance drop consistently despite a reasonable result from trades. Doing some digging I noticed that the AUD (my base currency) has appreciated ~5% over the past month/~11% since I started back with SO which -at ~2/3 committed capital- would account for the decline in value.

Given that currencies are relatively stable over time -AUDUSD has just returned to pre crisis levels- do you all try to hedge the impact or just view it as an occasional source of excess return/loss?

 

[MH74 16]

On 6/2/2020 at 3:41 PM, gf58 said:

A quick question for those who have non-USD base currency accounts, do you normally hedge your SO holdings? If so what methods are you using?

 

I've been by account balance drop consistently despite a reasonable result from trades. Doing some digging I noticed that the AUD (my base currency) has appreciated ~5% over the past month/~11% since I started back with SO which -at ~2/3 committed capital- would account for the decline in value.

Given that currencies are relatively stable over time -AUDUSD has just returned to pre crisis levels- do you all try to hedge the impact or just view it as an occasional source of excess return/loss?

 

 

currency hedging is an important component of investing. my reference currency is the CHF and I usually hedge my usd exposure with FX forwards. based on my personal assessment of the foreign currency, I hedge up to 100% so that I have no foreign currency exposure. At the moment I've hedged around 50% of the USD exposure. On the positive side, the hedging costs are low at present because of the interest rates (CHF and USD interest rates are about the same).

 

 

Edited June 6, 2020 by MH74

[gf58 771]

Thanks @MH74. Really appreciate the response. I hadn't really appreciated the importance until now as I guess last time I was with SO my cross was pretty stable (certainty not ripping 10% in 2 months). Long term, hedging will likely be a material cost for me as Australia is a relatively high interest rate economy although at the moment they're about as close as they've ever been.

Novice question: when you say FX forwards....how do you implement that? Is that as a specific forward contract with a bank or do you use futures contracts (like the globex mini/micro contracts) or something else?

[MH74 16]

Hi @gf58

yes, I process the forward exchange transactions via my bank. For example, if I want to reduce my USD exposure by USD 100k, I sell USD 100 forward against CHF. On this day, everything is fixed (forward exchange rate, maturity). Delivery is only made at the end of the term. Of course you can roll the deal, i.e. extend it. But you can also close the deal before the end of the term. No matter how the exchange rate develops from the beginning of the deal to the end of the term, I can (or have to) sell my USD at the exchange rate fixed in advance.

As a precondition for this deal, you have to sign a framework contract for forward transactions (probably also in Australia).

The difference between the forward exchange rate and the spot rate on the day the transaction is concluded, expressed as a percentage of the spot rate, is known as the swap rate. The swap rate is determined by international interest rate differences (e.g. USD and AUD).

 

 

[CJ912 136]

@gf58 as with everything in investing: have a look at your overall portfolio exposure. and think about the goal of hedging (or not hedging). Do you need to minimize that risk and at what potential expense?  There is quite a bit of interesting academic  research on the topic. I would suggest Campbell, Viceira, and White (2003) and  Campbell, Serfaty and Viceira (2009)

[gf58 771]

Thanks @MH74. That's very helpful detail. I honestly hadnt been able to find much online about the mechanics of how its done (although my search history means that Im now receiving every single 'trade forex for only 1 pip' banner ad in existence 😂). I can see my banks have FX forwards offerings so Ill investigate that. As a side thought, is a futures contract in any way analogous in that if 1 bought an AUDUSD contract for AUD10k @ USD6.5k, put down my 10%/USD650 margin I would then be exposed to 90%/AUD9k of AUD appreciation thus hedging 90%/USD5.8k of options positions?

Thanks @CJ912. Those references are very helpful. Id been working under the superficially thought through assumption that full hedging is optimal in all circumstances but those papers pointed out the impact of investment time horizon and other factors. I'll have to have a proper read tomorrow to get my head around it as there feels like there is a very real risk of material interest rate increases in Australia before the end of the year (our reserve bank cut rates to record lows more as a preemptive/throw the sink at it action...and the economy in true Australian style is actually not nearly that bad considering)

[MH74 16]

Hi @gf58

Yes, you're right. A currency future is the contractual obligation of two contracting parties to deliver a foreign currency at a specific date at a predetermined price. If you buy a currency future, you have the right to receive the foreign currency at the fixed price at the end of the term of the future. If you sell a currency future, you must deliver the foreign exchange at that time. As you can see, this is the exact same philosophy as the forward exchange transaction.

[gf58 771]

Excellent. Thanks @MH74. It seemed to work that way and I appreciate you confirming. Currency futures aren't something I'd utilised before but after having had a chat to my bank today it looks like they'd be an easier to manage hedge as I can more easily increase/decrease my hedge as my USD holdings vary (my bank gave me the impression that it was a rather onerous process to vary the size of the hedge on a regular basis).

I appreciate the help. Thanks again!

[Jasper 64]

@gf58 For a rise in AUD, do you have any opinion regarding hedging with call spreads on FXA (low liquidity) or put spreads on UUP? Something you would be able to manage yourself....

 

FWIW, hedging is on my mind when I have plans to withdraw USD to home currency in the foreseeable future. Otherwise I leave things to the ebb and flow of the market and quite like the diversification it achieves.

 

 

Edited June 27, 2020 by Jasper

[gf58 771]

@Jasper I ended up just using the M6A futures contracts. They have excellent liquidity/spreads and IIRC currency options behave differently to stock options somehow (I think its WRT to IV) and I wanted to keep this part as simple as possible.

 

They're worth AUD10,000 each so I go long 1 for each AUD10k of SO positions Im holding.

 

I dont really have an opinion on which way its going but absolutely hated the burn on my account from the run in May. I might have felt a little better about it if Id got the gains on the way down but alas. Makes sense to hedge if you're looking for certainty of payout; I could easily imagine a situation where the RBA raises rates earlier than the rest of the world if things clear up here much earlier.

[gf58 771]

😕 Maybe a question that should have occured to me long before.....but when hedging options positions, would one hedge the margin/capital at risk or the market value? Previously it wasnt a huge difference when trading a lot of straddles but now my portfolio has a larger component of credit ratios so there is a big deviation between the two.

 

Trying to think it through I presume that it would be the market value : If I buy a spread for USD 0.72 / AUD1.00 and the spread goes no where and I chose to exit for a 0% return I would want to be able to sell it for USD0.72 and be able to receive AUD1.00

 

If that is the case then I've just made a nice windfall through being drastically overhedged (Id been hedging off the margin requirement)...but wanted to check before I adjust.