Future, Forward, and Option Hedging

Agenda

Question 1: Future Hedging

Question 2: Option Hedging

Question 3: Forward Hedging

Agenda

Question 1: Future Hedging

Question 2: Option Hedging
Question 3: Forward Hedging

Question 1 Future Hedging

Input

Process

Control

Output

Question 1 Future Hedging

Input

Process

Output

Future Hedging
Current Condition

Implementation

Gross Profit
Net Profit

Control
Benefit
Consequences

Future Hedging - Input

Jamie Rodriguez, a currency trader for Chicago-based Ventosa Investments, uses the
following futures quotes on the British pound () to speculate on the value of the pound.
British
(CME)

Pound

Maturity

March
June

Futures,

US$/pound

Settle
1.4228
1.4162

Contract
pounds

62,500

Open Interest
25,605
809

a. If Jamie buys 5 June pound futures, and the spot rate at maturity is $1.3980/, what is
the value of her position?
b. If Jamie sells 12 March pound futures, and the spot rate at maturity is $1.4560/, what
is the value of her position?
c. If Jamie buys 3 March pound futures, and the spot rate at maturity is $1.4560/, what
is the value of her position?
d. If Jamie sells 12 June pound futures, and the spot rate at maturity is $1.3980/, what
is the value of her position?

Future Hedging - Input

Future Contracts
standardized contract between two parties to buy or sell a specified
asset of standardized quantity and quality for a price agreed upon
today with delivery and payment occurring at a specified future delivery
date

Standardized contract size and delivery date

Daily settlements in market places
Mostly settled by offset

Future Hedging - Process

a. If Jamie buys 5 June pound futures, and the spot rate at maturity is $1.3980/, what is
the value of her position?
Date

Spot Market

Future Market

Now

Not Available

$ 1.4162 /

June

$ 1.3980 /

$ 1.4162 /

$ 1.3980
$ 1.4162 _
($ 0.0182) /
(0.0182) x 62,500 = ($ 1,137.5)

Loss for 5 Contracts

$ 5,687.5

Future Hedging - Process

b. If Jamie sells 12 March pound futures, and the spot rate at maturity is $1.4560/,
what is the value of her position?
Date

Spot Market

Future Market

Now

Not Available

$ 1.4228 /

March

$ 1.4560 /

$ 1.4228 /

$ 1.4228
$ 1.4560 _
($ 0.0332) /
(0.0332) x 62,500 = ($ 2,075)

Loss for 12 Contracts

$ 24,900

Future Hedging - Process

c. If Jamie buys 3 March pound futures, and the spot rate at maturity is $1.4560/, what
is the value of her position?
Date

Spot Market

Future Market

Now

Not Available

$ 1.4228 /

March

$ 1.4560 /

$ 1.4228 /

$ 1.4560
$ 1.4228 _
$ 0.0332 /
0.0332 x 62,500 = $ 2,075

Profit for 3 Contracts

$ 6,225

Future Hedging - Process

d. If Jamie sells 12 June pound futures, and the spot rate at maturity is $1.3980/, what
is the value of her position?

Date

Spot Market

Future Market

Now

Not Available

$ 1.4162 /

March

$ 1.3980 /

$ 1.4162 /

$ 1.4162
$ 1.3980 _
$ 0.0182 /
0.0182 x 62,500 = $ 1,137.5

Profit for 12 Contracts

$ 13,650

Future Hedging - Output

Value of Jamies Position
Date

Contracts

Spot Market

Future
Market

June

Buys 5

$ 1.3980 /

$ 1.4162 /

Loss for $ 5,687.5

March

Sells 12

$ 1.4560 /

$ 1.4228 /

Loss for $ 24,900

March

Buys 3

$ 1.4560 /

$ 1.4228 /

Profit for $ 6,225

June

Sells 12

$ 1.3980 /

$ 1.4162 /

Profit for $ 13,650

Profit/Loss

Future Hedging - Control

Benefits

Consequences

Tradable (actively traded in the

market)

Legal obligation to fulfill

the contract

The obligation can be removed

before the expiry of the contract by
making an opposite transaction

Standardize (contract size, delivery

date, etc.)
Pay the initial

Agenda

Question 1: Future Hedging

Question 2: Option Hedging

Question 3: Forward Hedging

Question 2 Option Market

Input

Process

Control

Output

Question 2 Option Market

Input

Process

Output

Option Hedging
Current Condition

Implementation

Gross Profit
Net Profit

Control
Benefit
Consequences

Option Market - Input

Call
Option

Gives the buyer the right to sell a

specified currency at a specified
exchange rate, at or before a specified
date
Gives the buyer the right to buy a
specified currency at a specified
exchange rate, at or before a specified
date

Put
Option

Option Market - Input

Call
Option

In the money
if exchange rate < strike
price
At the money
if exchange rate = strike
price
Out of the money if exchange rate > strike
In the
money
if exchange rate > strike
price
price
At the money
if exchange rate = strike
price
Out of the money if exchange rate < strike
price

Put
Option

Option Market - Input

Sallie Schnudel trades currencies for Keystone Funds in Jakarta. She focuses
nearly all of her time and attention on the USD / SGD cross rate. The current spot
rate is $0.6000/S$. After considerable study, she has concluded that the Singapore
dollar will appreciate versus the US dollar in the
Option

Strike Price

Premium

Put on SGD

$0.65/S$

$0.00003/S$

Call on SGD

$0.65/S$

$0.00046/S$

a. Should Sallie buy a put on Singapore dollars or a call on Singapore dollars?

b. What is Sallies breakeven price on the option purchased in part (a)?
c. Using your answer from part (a), what is Sallies gross profit and net profit
(including premium) if the spot rate at the end of 90 days is indeed $0.7000/S$?
d. Using your answer from part (a), what is Sallies gross profit and net profit
(including premium) if the spot rate at the end of 90 days is indeed $0.8000/S$?

Option Market - Input

a. Should Sallie buy a put on Singapore dollars or a call on Singapore dollars?
Put Option

Spot Rate = 0.6000

0
-0.00003

Strike Price = 0.65

Premium = 0.00003

In the
money
0.65 Out of the
money

Option Market - Process

a. Should Sallie buy a put on Singapore dollars or a call on Singapore dollars?
Call Option

Spot Rate = 0.6000

0
-0.00046

In the
money
Out of the 0.65
money

Strike Price = 0.65

Premium = 0.00046

Sallie should buy call option

if Singapore dollars tends to
appreciate in the future

Option Market - Process

b. What is Sallies breakeven price on the option purchased in part (a)?
Call Option

Spot Rate = 0.6000

0
-0.00046

In the
money
Out of the 0.65 0.65046
money

Strike Price = 0.65

Premium = 0.00046
BEP= 0.65046

Option Market - Output

c. Using your answer from part (a), what is Sallies gross profit and net profit
(including premium) if the spot rate at the end of 90 days is indeed
$0.7000/S$?
Call Option

Spot Rate = 0.6000

0
-0.00046

In the
money
Out of the 0.65 0.65046
money

Strike Price = 0.65

Premium = 0.00046
Gross Profit
0.7000 0.65= S$ 0.0500

Net Profit
0.7000 0.65046= S$
0.04954

Option Market - Output

d. Using your answer from part (a), what is Sallies gross profit and net profit
(including premium) if the spot rate at the end of 90 days is indeed
$0.8000/S$?
Call Option

Spot Rate = 0.6000

0
-0.00046

In the
money
Out of the 0.65 0.65046
money

Strike Price = 0.65

Premium = 0.00046
Gross Profit
0.8000 0.65= S$ 0.1500

Net Profit
0.8000 0.65046= S$
0.14954

Option Market - Control

Benefit

Consequences

Limited downside risk

More expensive

Flexibility & variety of strategy

Risk of unhedged

Potentially provide significant

cash flow relief
Has the right but
not the obligation

http://www.lariba.com/knowledge-center/articles/pdf/Malaysia%20-%20GOLD%20-%20Hedging%20With%20Dinar.pdf

Agenda
Question 1: Future Hedging
Question 2: Option Hedging
Question 3: Forward Hedging

Question 3: Theory FX Forwards

Forward FX Outright Agreement
An agreement between two parties to exchange two currencies for
settlement on a fixed future date.

Premium = Forward Rate > Spot Rate

Discount = Forward Rate < Spot Rate

Question 3: Forward Hedging

Case 3 Question
Christoph Hoffeman trades currency for Blade Capital of Geneva.
Christoph has $10 million to begin with, and he must state all profits at
the end of any speculation in US dollars.
The spot rate on the euro is $1.3358/

Question A: Euro Appreciate

If Christoph Hoffeman believes the euro will continue to

rise in value against the US dollar, so that he expects the
spot rate to be $1.3600/ at the end of 30 days,
what should he do?

http:www.com

Question B: Euro Depreciate

If Christoph Hoffeman believes the euro will continue to

decrease in value against the US dollar, so that he
expects the spot rate to be $1.2800/ at the end of 30
days, what should he do?

http:www.com

Question 3 Forward Hedging

Input

Process

Control

Output

Question 3 Forward Hedging

Input

Process

Output

Forward Hedging
Current Condition

Implementation

Gross Profit
Net Profit

Control
Benefit
Consequences

Question A: Euro Appreciate

Question B: Euro Depreciate

Question 3: Forward Hedging

How to calculate FX forward rate
Given condition:
Spot rate: $1.3358/
US-interest rate: 0.25% annum
Euro-interest rate: 0.05% annum
30

Forward rate = 1.3358

1+0.0025 360
30

1+0.0005 360

= $1.3360/

http://www.global-rates.com/interest-rates/central-banks/central-bank-america/fed-interest-rate.aspx

Forward Hedging - Input

Forward Hedging Current Condition

Spot Rate

= $1.3358/ 0.7486/$

Forward rate = $1.3360/ 0.7485/$

Expected SR = $1.3600/ 0.7353/$
(A)
$1.2800/ 0.78125/$
(B)

Forward Hedging - Input

Question A: Euro Appreciate @ $1.36/
Hedging
Now

Sell $ forward @ 0.7485/$

30-days
later

Deliver $ and receive

$10 million * 0.7485/$ =
7,485,000

No Hedging

Deliver $ and receive

$10 million * 0.7353/$ =
7,353,000

The $ end up worth 7,485,000 - 7,353,000 = 132,000

higher
Decision: Mr. Christoph Hoffeman should Hedge

Forward Hedging - Input

Question B: Euro Depreciate @ $1.28/
Hedging
Now

Sell $ forward @ 0.7485/$

30-days
later

Deliver $ and receive

$10 million * 0.7485/$ =
7,485,000

No Hedging

Deliver $ and receive

$10 million * 0.7353/$ =
7,812,500

The $ end up worth 7,812,500 - 7,485,000 = 327,500

higher
Decision: Mr. Christoph Hoffeman should not Hedge

Forward Hedging - Input

Profit in terms of $
Question A

132,000 * $1.3360 = $176,352

Question B

372,500 * $1.2800 = $419,200

Forward Hedging - Control

Gross Profit
Net Profit

Benefit
Consequenc
es

Benefits

Consequences

No premium or payment upfront

Loss opportunity to make money

Mitigate risk of currency volatility

Securing value of your asset

Future, Forward, and Option Hedging