Forex for a trader
Forex hedging ppt

Forex hedging pptWhat is hedging as it relates to forex trading? Hedging is a strategy to protect one's position from an adverse move in a currency pair. Forex traders can be referring to one of two related strategies when they engage in hedging. A forex trader can create a “hedge” to fully protect an existing position from an undesirable move in the currency pair by holding both a short and a long position simultaneously on the same currency pair. This version of a hedging strategy is referred to as a “perfect hedge” because it eliminates all of the risk (and therefore all of the potential profit) associated with the trade while the hedge is active. Although this trade setup may sound bizarre because the two opposing positions simply offset each other, it is more common than you might think. Oftentimes this kind of “hedge” arises when a trader is holding a long, or short, position as a long-term trade and incidentally opens a contrary short-term trade to take advantage of a brief market imbalance. Interestingly, forex dealers in the United States do not allow this type of hedging. Instead, they are required to net out the two positions – by treating the contradictory trade as a “close” order. However, the result of a “netted out” trade and a hedged trade is the same.

A forex trader can create a “hedge” to partially protect an existing position from an undesirable move in the currency pair using Forex options. Using forex options to protect a long, or short, position is referred to as an “imperfect hedge” because the strategy only eliminates some of the risk (and therefore only some of the potential profit) associated with the trade. To create an imperfect hedge, a trader who is long a currency pair, can buy put option contracts to reduce her downside risk, while a trader who is short a currency pair, can buy call options contracts to reduce her upside risk. Imperfect Downside Risk Hedges: Put options contracts give the buyer the right, but not the obligation, to sell a currency pair at a specified price (strike price) on, or before, a pre-determined date (expiration date) to the options seller in exchange for the payment of an upfront premium. For instance, imagine a forex trader is long the EURUSD at 1.2575, anticipating the pair is going to move higher, but is also concerned the currency pair may move lower if the upcoming economic announcement turns out to be bearish. She could hedge a portion of her risk by buying a put option contract with a strike price somewhere below the current exchange rate, like 1.2550, and an expiration date sometime after the economic announcement. If the announcement comes and goes, and the EURUSD doesn’t move lower, the trader is able to hold onto her long EURUSD trade, making greater and greater profits the higher it goes, but it did cost her the premium she paid for the put option contract. However, if the announcement comes and goes, and the EURUSD starts moving lower, the trader doesn’t have to worry as much about the bearish move because she knows she has limited her risk to the distance between the value of the pair when she bought the options contract and the strike price of the option, or 25 pips in this instance (1.2575 – 1.2550 = 0.0025), plus the premium she paid for the options contract. Even if the EURUSD dropped all the way to 1.2450, she can’t lose any more than 25 pips, plus the premium, because she can sell her long EURUSD position to the put option seller for the strike price of 1.2550, regardless of what the market price for the pair is at the time. Imperfect Upside Risk Hedges. Call options contracts give the buyer the right, but not the obligation, to buy a currency pair at a specified price (strike price) on, or before, a pre-determined date (expiration date) from the options seller in exchange for the payment of an upfront premium. For instance, imagine a forex trader is short the GBPUSD at 1.4225, anticipating the pair is going to move lower, but is also concerned the currency pair may move higher if the upcoming Parliamentary vote turns out to be bullish. She could hedge a portion of her risk by buying a call option contract with a strike price somewhere above the current exchange rate, like 1.4275, and an expiration date sometime after the scheduled vote. If the vote comes and goes, and the GBPUSD doesn’t move higher, the trader is able to hold onto her short GBPUSD trade, making greater and greater profits the lower it goes, and all it cost her was the premium she paid for the call option contract. However, if the vote comes and goes, and the GBPUSD starts moving higher, the trader doesn’t have to worry about the bullish move because she knows she has limited her risk to the distance between the value of the pair when she bought the options contract and the strike price of the option, or 50 pips in this instance (1.4275 – 1.4225 = 0.0050), plus the premium she paid for the options contract.

Even if the GBPUSD climbed all the way to 1.4375, she can’t lose any more than 50 pips, plus the premium, because she can buy the pair to cover her short GBPUSD position from the call option seller at the strike price of 1.4275, regardless of what the market price for the pair is at the time. What is a 'Forex Hedge' A forex hedge is a transaction implemented by a forex trader or investor to protect an existing or anticipated position from an unwanted move in exchange rates. By using a forex hedge properly, a trader who is long a foreign currency pair, or expecting to be in the future via a transaction can be protected from downside risk, while the trader who is short a foreign currency pair can protect against upside risk. It is important to remember that a hedge is not a money making strategy. Forex Options Trading. Foreign Exchange Market. BREAKING DOWN 'Forex Hedge' The primary methods of hedging currency trades for the retail forex trader is through spot contracts and foreign currency options. Spot contracts are the run-of-the-mill trades made by retail forex traders. Because spot contracts have a very short-term delivery date (two days), they are not the most effective currency hedging vehicle. In fact, regular spot contracts are often why a hedge is needed.

Foreign currency options are one of the most popular methods of currency hedging. As with options on other types of securities, foreign currency options give the purchaser the right, but not the obligation, to buy or sell the currency pair at a particular exchange rate at some time in the future. Regular options strategies can be employed, such as long straddles, long strangles, and bull or bear spreads, to limit the loss potential of a given trade. (See also: Getting Started In Forex Options ) For example, if a U. S. company was scheduled to repatriate some profits earned in Europe it could hedge some, or part of the expected profits through an option. Because the scheduled transaction would be to sell euro and buy U. S. dollars, the company would buy a put option to sell euro. By buying the put option the company would be locking in an 'at-worst' rate for its upcoming transaction, which would be the strike price. And if the currency is above the strike price at expiry then the company would not exercise the option and do the transaction in the open market. Not all retail forex brokers allow for hedging within their platforms. Be sure to research the broker you use before beginning to trade. Hedging - PowerPoint PPT Presentation. To view this presentation, you'll need to enable Flash. After you enable Flash, refresh this webpage and the presentation should play. PPT – Hedging PowerPoint presentation | free to download - id: 6bf98-MTk0Z.

The Adobe Flash plugin is needed to view this content. You are speculating in Hog Futures. You think that the Spot Price of hogs will rise in the future. Thus, you go Long on 10 Hog Futures. . – PowerPoint PPT presentation. Title: Hedging. 1 Hedging Futures Today We will return to Capital Budgeting Financing. We will discuss how to reduce risk. Topics How to eliminate risk in capital budgeting.

(i. e. variable costs) How to eliminate risk in financing (i. e. interest rate fluctuations) HOW? By Hedging Futures Contracts 2 Ex - Cereal Production Ex - Kellogg produces cereal. A major component and cost factor is sugar. Forecasted income sales volume is set by using a fixed selling price. Changes in cost can impact these forecasts. To fix your sugar costs, you would ideally like to purchase all your sugar today, since you like todays price, and made your forecasts based on it. But, you can not. You can, however, sign a contract to purchase sugar at various points in the future for a price negotiated today. This contract is called a Forward Contract. This technique of managing your sugar costs is called Hedging. 3 Type of Contracts 1- Spot Contract - A K for immediate sale delivery of an asset. 2- Forward Contract - A K between two people for the delivery of an asset at a negotiated price on a set date in the future.

3- Futures Contract - A K similar to a forward contract, except there is an intermediary that creates a standardized contract. Thus, the two parties do not have to negotiate the terms of the contract. The intermediary is the Commodity Clearing Corp (CCC). The CCC guarantees all trades provides a secondary market for the speculation of Futures. 4 Types of Futures Commodity Futures - Sugar - Corn - OJ - Wheat - Soy beans - Pork bellies Financial Futures - Tbills - Yen - GNMA - Stocks - Eurodollars Index Futures - SP 500 - Value Line Index - Vanguard Index 5 Futures Contract Concepts Not an actual sale Always a winner a loser (unlike stocks) K are settled every day. (Marked to Market) Hedge - K used to eliminate risk by locking in prices Speculation - K used to gamble Margin - not a sale - post partial amount Hog K 30,000 lbs Tbill K 1.0 mil Value line Index K index x 500 6 Ex - Settlement Speculate You are speculating in Hog Futures. You think that the Spot Price of hogs will rise in the future. Thus, you go Long on 10 Hog Futures. If the price drops .17 cents per pound (.0017) what is total change in your position? 30,000 lbs x .0017 loss x 10 Ks 510.00 loss 50.63 cents per lbs 50.80 -510 Since you must settle your account every day, you must give your broker 510.00 7 Ex - Commodity Hedge You are an Illinois farmer. You planted 100 acres of winter wheat this week, and plan on harvesting 5,000 bushels in March. If todays wheat price is 1.56 per bushel, and you would like to lock in that price, what would you do? Since you are long in Wheat, you will need to go short on March wheat. Since 1 K 5,000 bushels, you should short one contract and close your position in March.

8 Ex - Commodity Hedgereal world In June, farmer John Smith expects to harvest 10,000 bushels of corn during the month of August. In June, the September corn futures are selling for 2.94 per bushel (1K 5,000 bushels). Farmer Smith wishes to lock in this price. Show the transactions if the Sept spot price drops to 2.80. Revenue from Crop 10,000 x 2.80 28,000 June Short 2K _at_ 2.94 29,400 Sept Long 2K _at_ 2.80 28,000 . Gain on Position------------------------------- 1,400 Total Revenue 29,400 9 Ex - Commodity Hedgereal world In June, farmer John Smith expects to harvest 10,000 bushels of corn during the month of August. In June, the September corn futures are selling for 2.94 per bushel (1K 5,000 bushels). Farmer Smith wishes to lock in this price. Show the transactions if the Sept spot price rises to 3.05. Revenue from Crop 10,000 x 3.05 30,500 June Short 2K _at_ 2.94 29,400 Sept Long 2K _at_ 3.05 30,500 . Loss on Position------------------------------- ( 1,100 ) Total Revenue 29,400 10 Ex - Commodity Speculationreal world You have lived in NYC your whole life and are independently wealthy. You think you know everything there is to know abot pork bellies (uncurred bacon) because your butler fixes it for you every morning. Because you have decided to go on a diet, you think the price will drop over the next few months. On the CME, each PB K is 38,000 lbs. Today, you decide to short three May Ks _at_ 44.00 cents per lbs. In Feb, the price rises to 48.5 cents and you decide to close your position.

What is your gainloss? Nov Short 3 May K (.4400 x 38,000 x 3 ) 50,160 Feb Long 3 May K (.4850 x 38,000 x 3 ) - 55,290 Loss of 10.23 - 5,130 11 Margin The amount (percentage) of a Futures Contract Value that must be on deposit with a broker. Since a Futures Contract is not an actual sale, you need only pay a fraction of the asset value to open a position margin. CME margin requirements are 15 Thus, you can control 100,000 of assets with only 15,000. 12 Ex - Commodity Speculationreal world - with margin You have lived in NYC your whole life and are independently wealthy. You think you know everything there is to know abot pork bellies (uncurred bacon) because your butler fixes it for you every morning. Because you have decided to go on a diet, you think the price will drop over the next few months. On the CME, each PB K is 38,000 lbs. Today, you decide to short three May Ks _at_ 44.00 cents per lbs. In Feb, the price rises to 48.5 cents and you decide to close your position. What is your gainloss? Nov Short 3 May K (.4400 x 38,000 x 3 ) 50,160 Feb Long 3 May K (.4850 x 38,000 x 3 ) - 55,290 Loss - 5,130 Loss 5130 5130 Margin 50160 x.15 7524 ------------ -------------------- ------------ 68 loss 13 Financial Futures Goal (Hedge) - To create an exactly opposite reaction in price changes, from your cash position. Commodities - Simple because assets types are standard. Financials - Difficult because assets types are infinte. - You must attempt to approximate your position with futures via Hedge Ratios. 14 Ex - Financial Futures Example - Hedge Cash Position Futures Position Nov Long 1,000 Short 1K _at_970 March Sell _at_ 930 Long 1K _at_900 loss 70 gain 70 Net position 0 15 Ex - Financial Futures Example - Hedge Reality Cash Position Futures Position Nov Long 1,000 Short 1K _at_970 March Sell _at_ 930 Long 1K _at_920 loss 70 gain 50 Net position 20 loss 16 Ex - Financial Futures You are long in 1mil of bonds (15 yr 8.3125 bonds) The current YTM is 10.45 and the current price is 82-17. You want to cash out now, but your accountant wants to defer the taxes until next year. The March Bond K is selling for 80-09. Since each K is 100,000, you need to short 10 March Ks. In March you cash out with the Bond price 70-26 and the K price 66-29. What is the gainloss?

17 Ex - Financial Futures You are long in 1mil of bonds (15 yr 8.3125 bonds) The current YTM is 10.45 and the current price is 82-17. You want to cash out now, but your accountant wants to defer the taxes until next year. The March Bond K is selling for 80-09. Since each K is 100,000, you need to short 10 March Ks. In March you cash out with the Bond price 70-26 and the K price 66-29. What is the gainloss? Cash Futures Basis Nov 825,312 802,81 2 (2-8) March 708,125 669,062 (3-29) GainLoss (117,187) 133,750 (1-21) Net Gain 16,563 ( 1-21 x 1mil) 18 Financial Futures The art in Financial futures is finding the exact number of contracts to make the net gainloss 0. This is called the Hedge Ratio Face Value Cash Face Value of Futures K of Ks ---------------------------------- X Hedge Ratio HR Goal - Find the of Ks that will perfectly offset cash position. 19 Hedge Ratio Determination 1 - The Duration Model 2 - Naive Hedging Model 3 - Conversion Factor Model 4 - Basis Point Model 5 - Regression Model 6 - Yield Forecast Model 20 Swaps An agreement between two firms in which each firm agrees to exchange (or Swap) the interest rate charachteristics of two different financial instruments of identical principal. Types Interest Rate Swaps Currency Swaps 21 Ex - Interest Rate Swaps Aaa Corp Baa Corp L. T. Fixed Loan 10 11.5 S. T. Variable Loan 7.25 7.50 Swap Aaa Corp Borrows 1mil fixed loan _at_ 10 BAA Corp Borrows 1mil variable loan _at_ 7.5 Aaa assumes pmts on variable loan at 7.5 Baa assumes pmts on fixed loan _at_ 10.75 22 Ex - Interest Rate Swaps Aaa Corp Baa Corp L. T. Fixed Loan 10 11.5 S. T. Variable Loan 7.25 7.50 Aaa Benefit Baa Benefit Pay L. T. _at_ -10.00 Pay S. T. _at_ - 7.50 Get L. T. _at_ 10.75 Get S. T. _at_ 7.50 Pay S. T. _at_ - 7.50 Pay L. T. _at_ -10.75 S. T. Sav _at_ 7.25 L. T. Sav _at_ 11.50 Net Benefit .50 Net Benefit .75. PowerShow. com is a leading presentationslideshow sharing website. Whether your application is business, how-to, education, medicine, school, church, sales, marketing, online training or just for fun, PowerShow. com is a great resource. And, best of all, most of its cool features are free and easy to use. You can use PowerShow.

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