Options are for wimps

26-04-2016 | by Rob Soentken |

bankingDoes it make sense to use options for hedging? The following little story is about a senior person who I respect a lot, and who didn’t like using options.

One day he asked me to execute some call options for his investment book. He never used options, so I asked him if he had changed his mind about the product. He just laughed and said he hadn’t.

“Why would I buy an option if I know the prices are going up? Any option premium I pay is lost money.” 

Somehow I’m convinced he held the same opinion about selling options.

Value of a USD and Call option on a USD

Options are for wimps - diagram 1Diagram 1 explains his feelings. I assume he was considering only the left half of the payoff diagram. After an appreciation of the USD, a USD is always worth more than a call option on a USD, the difference being the option premium.

There is no downside if you ‘know’ where the market is going, if there is no uncertainty. Using options implies you are not sure about the direction. In a way he was saying ‘options are for wimps’.

The future of the USD is leading

For a company importing goods from outside the EUR zone the choice could be very similar: to buy the foreign currency outright or buy a call option on that currency. Possible actions are driven by the views on 2 dimensions of the USD future:

  1. Where will USD go? Down or Up?Where will USD go?
  2. How will USD go there? Steadily or Uncertainly?

These 2 dimensions lead to 4 possible actions for hedging currency risk, as depicted in Diagram 2.

If the view on USD is Up, in a Steadily way the choice to ‘buy USD or buy an option’ is straightforward: Buy 100% of the required USD, because any option premium would be wasted money.

If the view on USD is Up but in an Uncertain manner, it could be recommendable to buy 100% At-The-Money options. Obviously the premium is an expense, but considering the expected Uncertain price action the price of USD could also be going down, meaning the USD can be purchased against cheaper than expected prices. This would represent a gain possibly offsetting and exceeding the loss of the premium.

If the view on USD is Down and in an Uncertain manner, it could be recommendable to buy 100% Out-Of-The-Money options. Like my manager in the beginning of this article, this call would be a back-stop against unexpected outcomes. Obviously the premium is an expense, but considering the strike being Out-Of-The-Money, it’s a relatively small one.

Finally, if the view on the USD is Down, and in a Steadily way it could be an interesting approach to hedge a certain percentage and to add to that position in a dynamic way, until the full 100% of the required USD amount has been purchased. In a way this position is a replication of buying a Call option, without incurring the expense of the premium. Obviously there could and would be cost involved if additional USD purchases would be above the initial purchase. But if the Down view materialises, there would be gains in the form of cheaper USD purchases.

Above article reflects the personal views of the writer. It should not be used as a guidance to the use of derivatives in the context of investments or risk management. Any investor or risk manager should develop and determine their own independent views and actions.

Rob Soentken


Rob Söentken

Ex-derivatives trader

Rousseff impeachment: short-term strength for BRL

brasil22-04-2016 | by Simon Knappstein |

Will the ousting of President Rousseff help the Brazilian Real to strengthen or not?

From a high of 4,15 at the end of January USD/BRL has fallen steadily to 3,55 level today. This strengthening came on the back of a broadly weaker USD, a rebounding oil price, renewed inflow into Emerging Markets in general and supported by a high carry for the BRL more specifically.


What has played an important role more recently is the diminishing popularity of president Dilma Rousseff. This comes in part by a massive corruption scandal at state-run oil company Petrobras with a lot of Worker’s Party politicians already convicted. Yesterday, the Brazilian Lower House voted for her impeachment over allegations for manipulating government accounts to hide a budget shortfall. All this has crippled the government’s ability to deal with an economic recession and rising unemployment.

The consensus FX forecast for USD/BRL, with current spot at 3.62, is 3.90 in 12 months’ time.

Consensus FX forecast for USDBRL

According to Nordea the potential impeachment of president Rousseff is a “short-term positive for the BRL at best. Short-term positive because markets seem to cheer the potential for change and for more political stability under Vice President Temer, albeit with the recognition that the BRL has already strengthened a lot and that most of the impeachment may be priced. More importantly, however, Brazil’s huge and numerous challenges will not go away with President Rousseff and markets may soon realize that.”

ING that expects USD/BRL to trade at 4.05 in one year’s time states: “Yet, we continue to see a high risk of the current market euphoria to fade as an impeachment does not necessary mean a highly stable political environment thereafter”. That might be an understatement as vice-president Temer, who would assume power on an interim basis when Rousseff has to step aside, also runs the risk of an impeachment process.

And although, as Scotiabank poses it “hopes that changes in the country’s leadership could lead to more market friendly economic policies” market participants seem to underestimate that “Brazil is undergoing a deep economic crisis exacerbated by a profound crack in its political institutions” and more specifically underestimate “the nature of the structural change required to rebuild credible political institutions”. Scotia sees the BRL weakening to 4.20 in 11 months’ time.

So in the short-term the BRL might strengthen a bit further still but further out it is still in general expected to weaken to around 4.0 against the USD.

Simon Knappstein - editor treasuryXL


Simon Knappstein

Owner of FX Prospect

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Negative Interest Rate Policy: No lasting effect on FX

14-04-2016 | by Simon Knappstein |



Negative interest rates are gripping Central Banks worldwide. The BoJ has resorted to this unexpected and unusual policy at the end of January. The ECB is expected to dig deeper into negative realms at their March meeting. The Swedish Riksbank has also gone negative and the Fed is contemplating the possibility for the eventuality economic growth will falter and inflation will fall. And of course the Swiss are already quite accustomed to negative interest rates. But in the FX markets the effects are minimal and short-lived.

So, are Central banks reaching the end of the effectiveness of their extremely loose monetary policies? If so, the big question is what next? Plain currency intervention? Hard to imagine currently, though the Swiss National Bank is said to be continuously intervening to prop up EUR/CHF.

The ECB has crossed the zero interest rate border in the summer of 2014 bringing its depo-rate to minus 0.10%. A move intended to stimulate credit growth by commercial banks, and as a means to lower the value of the Euro as to import more inflation. Although the latter was not explicitly mentioned everyone knows it was.

Since then the Swiss National Bank in December 2014, the Riksbank in February 2015 and the Bank of Japan in January 2016 have followed suit by introducing negative interest rates.

Currency impact

Interest rates
Figure 1 – Currency impact

The impact on the currency exchange rate is questionable and certainly not a straightforward main driver, as can be seen in figure 1.
When the ECB introduced a negative interest rate in the summer of 2014 it was accompanied by the start of the QE program and indeed EUR/USD moved considerably lower. The rate cut to -0.3% last December had no material impact on the exchange rate, even though it was followed by the first Fed rate hike in years.

The pressure on EUR/CHF could not be relieved by a rate cut to -0.25% in December 2014 so it was soon followed by the abandoning of the minimum exchange rate at 1.20 and a further cut to -0.75%. EUR/CHF stabilized but only continuous intervention by the SNB has brought the pair higher since then. The charts for EUR/SEK and USD/JPY speak for itself.

The conclusion is that there is very little to no evidence that negative interest rates lead to weaker currencies to support inflationary pressures.

Simon Knappstein - editor treasuryXL



Simon Knappstein

Owner of FX Prospect


Consensus FX forecasts March 2016

30-03-2016 | by Simon Knappstein |

FX forecast


The March edition of the consensus FX forecasts report shows that spot US Dollar has weakened broadly since February. In the forecasts for 1 year the changes for he USD are less strong and more diverse though.  

Changes vs. February

Against the CAD and RUB the USD is expected to weaken a little more than last month. The oil price is a main driver here. Less strengthening is seen in 1 year against the Indonesian Rupiah IDR and against the South African Rand ZAR. Both are supported by a high carry, and in the case of the IDR coordinated action in the form of economic reforms and interest rate cuts is supporting economic growth and the Rupiah.
Against the general direction of a weakening USD there are a few currencies against which the USD is expected to strengthen more versus last month. These are the Indian Rupee INR, the Turkish Lira TRY and the Korean Won KRW. For the specifics here please see the comments in the report.

Market Focus

Developed Markets

Although the Fed has voiced a softer tone on the interest rate path, the USD is still expected to strengthen supported by tighter monetary policy from the Federal

Reserve this year. A hawkish re-pricing of the 2016 path presents upside risk to the USD.
Expect the EUR to weaken on the basis of policy divergence and interest rate differentials.
The Brexit threat has provided for a sizeable drop in GBP; risks remain tilted to the downside into the June 23 referendum.
The recovery in oil prices is still fragile and a pullback would punish the CAD. Over the longer term, the CAD should take flight anew more sustainably, in step with the oil price recovery and the improved economic environment in Canada.
JPY is expected to weaken, as it reverses its YTD sentiment-driven gains and monetary policy divergence takes the upper hand again.

AUD sentiment might be tentatively turning the corner, but AUD remains vulnerable to a slowing Chinese economy.

Emerging Markets

The RUB stabilised on the back of a rising oil price, but the recovery is fragile and tentative.
TRY found some support during the recent risk-on period but idiosyncratic risks and on-going geopolitical risks are expected to weigh on the TRY.


The BRL has recovered somewhat thanks to a combination of high yields and a more benign global risk environment. Political risk remains high and unwinding of the carry trade might see a sharp weakening of the BRL.
MXN has responded positively to aggressive and concerted policy action. Further gains in MXN are expected.


CNY should weaken modestly in response to slower growth and central bank policy accommodation.
IDR is supported by a change in investor sentiment on the back of coordinated action by the central bank and government.
Simon Knappstein - editor treasuryXL


Simon Knappstein

Owner of FX Prospect