Optimizing FX Risk Management Using Options Shan Anwar Director, FX ebay Julie Bennett SVP, Thought Leadership HSBC
Heard on the Street Options are complicated We hedge opportunistically Our risk management committee can t agree whether the dollar is strengthening or weakening We improve our hedges by managing the strikes and maturities We just want certainty We want flexibility to benefit from upside We don t like the cost
In Practice FX Instruments Used 2016 Deloitte Survey Collars Purchased FX Options FX Swaps Aligned with observed practice Some common trends in option use may be observed within industries Forwards and NDFs 0% 50% 100% (*) Source: Deloitte, 2016 Global Foreign Exchange survey 133 corporations globally through a wide range of size, geographies and industries https://www2.deloitte.com/content/dam/deloitte/uk/documents/risk/deloitte-uk-global-foreign-survey-16.pdf
Why FX Options? Certainty of Worst Case Protection Rate Participation in Upside Flexibility to Manage Less-than-Certain Exposures Allow for Dynamic Hedging and Restructuring Limited, Known, and Fixed Downside Risk Optimize Available Credit / Dealing Lines
Opportunity to Reflect View Weakness View on Sold Currency Strength Forward Participating Forward Collar Forward Extra Purchased Option Upside Participation
Forwards Are Not Costless Opportunity Regret risk of market execution timing Liquidity Potential cash outflow if rolling hedge or timing mismatch with underlying hedged transaction
Liquidity Risk: Cash Settlements GBPUSD Rolling Forwards: Can the Moves Below Zero be Supported? 50% 40% 30% 20% 10% 0% -10% -20% Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 12M Cash Settlement at Expiry 3M Cash Settlement at Expiry
Forwards Are Not Costless Opportunity Regret risk of market execution timing Liquidity Dealing Lines and Charges Carry Cost Potential cash outflow if rolling hedge or timing mismatch with underlying hedged transaction Consumption of dealing lines and potential charges, particularly for longer tenors May pay through the forward points, particularly in Emerging Markets
Forward Carry Cost USDMXN: Forwards and Realized Spot 22.00 20.00 18.00 16.00 14.00 12.00 10.00 Dec-02 Apr-05 Aug-07 Dec-09 Apr-12 Aug-14 Dec-16
Forward Carry Cost vs. Premium USDMXN: Option Premium vs. Forward Points Implied Carry 5% 4% 3% 2% 1% 0% -1% -2% Jan-12 Oct-12 Jul-13 Apr-14 Jan-15 Nov-15 Aug-16 May-17
Market vs. Realized Volatility USDMXN: Implied vs. Realized Volatility (1 Year) 20% 17% 14% 11% 8% 5% Jan-12 Oct-12 Jul-13 Apr-14 Jan-15 Nov-15 Aug-16 May-17 Implied Realized
Cost of Options vs. Market Moves GBPUSD: Annual Spot Range vs. ATMF Premium (% of Notional) 40% 35% 30% 25% 20% 15% 10% 5% 0% 2008 2009 2010 2011 2012 2013 2014 2015 2016 Spot Range ATMF Option Premium
Hedging USDJPY: Forward v. Option Period End Spot Rate / Achieved Hedge Rate 130 120 110 100 90 80 70 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15 Oct-16 Oct-17 Unhedged Forwards Only Options Only
Hedging USDJPY: Forward v. Option Average Annual Hedged Rate 120 110 100 90 80 70 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Forwards Only Options Only 50/50
Reduced Volatility and Upside Performance (P&L as % Notional): 2008-2017 15% 10% 5% 0% -5% -10% -15% -20% Unhedged Forwards Only Options Only Mixed 50/50 Strategy Median Average
Option Value (% EUR) Managing Options Option Value 4% Evolution of EURUSD Put Option Premium = 3% Spot Time Value + Intrinsic Value 2% 1% 0% Initial Spot Spot c. 70% 6M 1Y
Options in a Layered Strategy Months Prior to Cash Flow Layering Approach Hedge Layer Total Hedged 18M 20% 20% 15M 20% 40% 12M 20% 60% 9M 20% 80% 6M 0% 80% Comparison of Strategies Unhedged Forwards ATMF Purchased Options Longer Dated ATMF Purchased Options + Forwards 3M 20% 100%
Hedging GBPUSD Period End Spot Rate / Achieved Hedge Rate 2.00 1.90 1.80 1.70 1.60 1.50 1.40 1.30 1.20 Jan-08 Apr-09 Jul-10 Oct-11 Jan-13 Apr-14 Jul-15 Oct-16 Unhedged Forwards Only Options Only
Using Options and Forwards Period End Spot Rate / Achieved Hedge Rate 2.00 1.80 1.60 1.40 1.20 Jan-08 Apr-09 Jul-10 Oct-11 Jan-13 Apr-14 Jul-15 Oct-16 Unhedged Forwards Only Options Only Blended
Reducing Volatility 10% 5% 0% -5% -10% -15% -20% -25% -30% -35% Performance (P&L as % Notional): 2008-2017 Unhedged Only Forwards Only Options Blended: Options Median Average and Forwards
Further Applications for Options Net Investment Hedging Event Driven Risk Management
Transaction Certainty Further Applications for Options Event Driven Risk Management An initial option strategy provides a worst case rate for a known cost, while providing flexibility to refine the hedge as certainty increases Many conditions and approvals outstanding Some hurdles cleared No uncertainty for all conditions to be met Purchased Option Deal Contingent Hedge* Collar Forward * Availability of deal contingents depends on deal specifics
Further Applications for Options Net Investment Hedging Optimize Hedge Portfolio / Capacity Event Driven Risk Management
MtM (USD) GBPUSD MtM (USD) GBPUSD Further Applications for Options Optimize Hedge Portfolio / Capacity Using Options to Limit Mark to Market ATM Option OTM Option 58M 1.69 58M 1.69 Example: Manage potential collateral requirements from existing cross currency swap portfolio with FX option 8M -42M -92M -142M -192M 1.49 1.29 1.09 0.89 0.69 8M 1.49-42M 1.29-92M 1.09-142M 0.89-192M 0.69 90% Confidence Interval 50% Confidence Interval MtM Cap with Option Strategy
Further Applications for Options Net Investment Hedging Optimize Hedge Portfolio / Capacity Event Driven Risk Management Binary Events
# of Options Traded Further Applications for Options Binary Events GBPUSD Options Traded - Expires Jun/Jul ( 15 v. 16) 1800 Options may be considered for protection in reference to a binary event risk 1300 800 300-200 Jan Feb Mar Apr May Jun
Final Thoughts & Takeaways Valuable tool in the toolkit Achieve certainty and limit regret risk Building blocks to design a hedge aligned with specific objectives or exposure Manage options to optimize value