Currency Hedging

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titansrulev2

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If you’re a US fund manager with a EUR position and you’re worried about USD appreciation, how would you collar the currency exposure in EUR/USD terms? Say spot is .66 and puts and calls are available at .68 and .64.
 
If you are worried about the USD strengthening, then you are concerned that the EUR/USD rate will go down. So you buy the lower strike put and sell the higher strike call to fund the premium of the put. You are protecting downside in the EUR/USD rate and giving up some upside to pay for the protection.
 
You guys are offering opposite solutions. Work it out amongst yourselves.
 
mdsds wrote:
If you are worried about the USD strengthening, then you are concerned that the EUR/USD rate will go down.
Click to expand...
this is not the case. If I am worried about USD strengthening then I am worried EUR/USD will go up; i.e., I am worried base currency (USD) will strengthen (go up)
 
Seriously, folks: this cannot be that hard, especially at Level III.
If you’re concerned about the price of something dropping, you buy puts (at a price below the spot), and to finance that purchase you sell calls (at a price above the spot).
Here, the US fund manager (you) is (are) concerned about the USD appreciating vis-à-vis the EUR, or the EUR depreciating vis-à-vis the USD: he’s (you’re) worried that the price of the EUR (measured in USD) will drop. Your action is clear: buy puts on the EUR and sell calls on the EUR; i.e., buy USD/EUR puts (below the spot) and sell USD/EUR calls (above the spot).
Ah … you say … but that’s the rub: we don’t have USD/EUR puts and calls; we have EUR/USD puts and calls.
The solution is the paradigm of simplicity: a USD/EUR put (below the spot) is an EUR/USD call (above the spot), and a USD/EUR call (above the spot) is an EUR/USD put (below the spot): buy EUR/USD 0.68 calls, and sell EUR/USD 0.64 puts.
Voilà!
 
Thanks. I had in my mind that this was essentially like collaring a short stock position, which would be to buy calls and sell puts.
 
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