Delta currency hedging?

[BMiller12]

What’s the purpose of delta hedging exchange rates with put options as opposed to using a simple futures contract? Seems like the outcome is the same/similar but that delta hedging is more costly.
Also don’t understand why, once the hedge is set up, why you have to adjust it (again, assuming no basis risk)?
thanks in advance!

 

[S2000magician]

BMiller12 wrote:What’s the purpose of delta hedging exchange rates with put options as opposed to using a simple futures contract? Seems like the outcome is the same/similar but that delta hedging is more costly.

The same as with delta hedging for, say, stocks; a futures/forward contract will ensure a particular exchange rate at a particular date in the future, but between now an then the rate could fluctuate and you’ve no protection against that. If, for example, you don’t know when you’ll be getting cash flows in a foreign currency, hedging with futures/forwards may not be pragmatic. Delta hedging is dynamic: you keep adjusting it and it keeps protecting you.

BMiller12 wrote:Also don’t understand why, once the hedge is set up, why you have to adjust it (again, assuming no basis risk)?

You adjust it for the same reason that you adjust any other delta hedge: delta changes.

BMiller12 wrote:thanks in advance!

My pleasure.

 

[BMiller12]

Maybe im losing sight that in one case you’re using futures, and options in the other. For example though, say you hedge $1mm by selling it forward. With regards to your first sentence, You don’t care that the rate moves bc you’re hedged in any event (assuming no basis risk), no? Just don’t see the advantage in using options dynamically if you have to constantly change the hedge and incur costs. Why not just use the future and be done?
Thanks So much S2.

 

[cpk123]

options give you the option of not exercising if the currency moves in the other direction. for this privilege you pay a price. (premium). – and to keep the ranges of losses within check (or to keep your gains within range - you need to now delta hedge - since delta moves as the option moves towards maturity).
in a futures / forward situation whether you like it or not, you would incur a loss if the currency moved in the direction.

 

[S2000magician]

BMiller12 wrote:Maybe im losing sight that in one case you’re using futures, and options in the other. For example though, say you hedge $1mm by selling it forward. With regards to your first sentence, You don’t care that the rate moves bc you’re hedged in any event (assuming no basis risk), no? Just don’t see the advantage in using options dynamically if you have to constantly change the hedge and incur costs. Why not just use the future and be done?

If you sell $1mm forward you have to decide on the expiration date of the forward contract. If you know that you’re getting $1mm in three months, there’s nothing wrong with that; as you say, no basis risk. But if you don’t know whether you’ll get it in 1 month, or 3 months, or 8 months, then the forward contract may not help you much; you could have beaucoup de basis risk. If you receive the $1mm before expiration of the contract, you’ll have to unwind it at the current rate, so you may be worse off. If you receive the $1mm after the expiration of the contract, you’ll have to roll it over, and the currency markets may be in contango.

BMiller12 wrote:Thanks So much S2.

My pleasure.

 

[BMiller12]

The book doesn’t specify. I think I understand that if your holding period I longer than your contract length, then you try to roll into a new contract with the desired remaining term. But if your holding period is less than the contract, what term futures contract do you reverse into to cash out? The book just says you reverse out at the current futures rate but doesn’t specify anything about it.

 

[2004028]

BMiller12 wrote:
The book doesn’t specify. I think I understand that if your holding period I longer than your contract length, then you try to roll into a new contract with the desired remaining term. But if your holding period is less than the contract, what term futures contract do you reverse into to cash out? The book just says you reverse out at the current futures rate but doesn’t specify anything about it.

I think with when your holding period is shorter than the contract. At end of your holding period, you can enter into a “reverse” position of the contract to offset the effect of the contract for the reminder time. By doing so, you essentially enter into a new contract which likely to have different spot and future rate than when you first enter in the the first contract. Hence the basis risk.

 

[Kiakaha]

With futures you are hedged between point A and point B. Unless point B corresponds exactly to your time horizon, you face basis risk. With delta hedging you are constantly hedged so there is no risk (although the number of billion dollar+ losses on delta desks would suggest this is bull$hit, but that is the theory at least)