Forward + Spot Strategy: Pros and Cons

Many businesses choose to hedge some of their forecasted cash flows and leave the balance to trade on the spot market later.

This can be useful if cash flows are not committed or the timing is uncertain

This is a bad idea if the objective is to speculate and seek (hope) for FX gains

In this article, I’ll explain how a forward+spot strategy works and introduce an alternative.

How does it work and, is it worth it?

Let’s say a UK importer has upcoming payables of EUR 1 million. A few months ago, they hedged 75% of this exposure with a forward contract at a rate of GBPEUR 1.15, leaving the other 25% to trade at the spot rate.

If the pound rises to €1.20, their costs would fall by £9,057

If the pound falls to €1.10, their costs would increase by £9,887

The chart below shows the difference in cost at various spot rates for the 75% hedge + 25% spot strategy compared to trading the full amount at €1.15.

This may or may not be a good solution. To assess this we’d need to understand:

• Hedging objectives
• Risk tolerance
• Certainty of the cash flow; amount and timing
• Sensitivity to changes in the spot rate

An Alternative?

It is possible to obtain a 100% hedge with less than 100% contractual obligation to exchange. Such a solution is achievable through the use of currency options but, we won’t go into too much detail here as we are not authorised by the FCA to deal in such financial instruments.

Disclaimer: At the time of publication, Oku Markets is not authorised by the Financial Conduct Authority. We do not carry on nor purport to carry on any regulated activity including, but not limited to, advising on investments, arranging investments, dealing in investments, or making arrangements with a view to transactions in investments. 

The chart below shows the total cost of purchasing EUR 1 million using the 75%+25% forward/spot strategy and, the alternative instrument (‘participating forward’) at a rate of €1.1425 – a less favourable initial protection rate.

Note that we’re deliberately using round numbers for the sake of the illustration