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Using Options To Hedge Carry Trade...is It Possible?

  • #1
  • First Post: Mar 10, 2007 12:27pm Mar 10, 2007 12:27pm
Greetings Guys and Dolls,

I have been wondering if it is at all possible, and if so is it viable for a retail trader to hedge a carry trade using options.

Now I know that in Forex we have the exotic/Vanilla options that are traded through the brokers. I must say I wasn't thinking about those options but certainly if U know of a strategy that uses these options so much the better if you would like to share it with us on these forums.

Rather what I was thinking was the use of options issued/traded in the PHLX. First of all can these options be used for a non-US dollar pair (e.g GPY/JPY or NZD/JPY) or is it only in relation to a pair with the USD?

Secondly what is the actual mechanism and liquidity of these options? ( I m not talking about the actual option greeks etc but rather the practicalities of the option purchase as i presume it would need some special arrangement between your forex bank/ Broker in order to co-ordinate the entire transaction.)

I m pretty sure that the big players..or rather (the folks that really know what they are doing!!) are hedged in the carry trade....I know that we hear a lot of ha hu about the unwinding of the carry trade day in day out for the last week or so on CNBC and other news wires.......its only the panic unwinding of the position from the guys who have not a very good idea what they are doing......the big players in the carry trade don't really care which way the market moves...as long as the interest are not equal. (thats what I ve concluded anyways!!) coz they know which way the market moves..they make money!!!!! ( those are the people I refer to as the 5% club!)

I guess what I m referring to here is the use of a Dynamic Hedge in stock trading in the Forex or any variant of it...

One last question I would like to know if you know the answer to the above is would the premiums paid for the usage of such options eat up the interest earned. Somebody did "indicate" to me that he believed the option premium would probably eat into the interest earned but he wasn't sure.....

So any handy hints on the above would be greatly welcomed......or even if anyone passing by has any info on any educational resources I can refer up on the matter I would be greatly appreciative....

Many thanks for your time...
  • #2
  • Mar 10, 2007 1:01pm Mar 10, 2007 1:01pm
Bad,

I have been looking into this myself, and it would seem that the premiums on the options actually price in the interest. So, in theory, it wouldn't work. What I suggest you do, is call up PHLX and get the premium on a 1-month, 3-month and 1-year option in a desired currency pair.

My guess is that your premium will pretty much be your interest and thensome.

By all means, let us know what you come up with.

Quoting Bad.hair.spray
Greetings Guys and Dolls,

I have been wondering if it is at all possible, and if so is it viable for a retail trader to hedge a carry trade using options.

Now I know that in Forex we have the exotic/Vanilla options that are traded through the brokers. I must say I wasn't thinking about those options but certainly if U know of a strategy that uses these options so much the better if you would like to share it with us on these forums.

Rather what I was thinking was the use of options issued/traded in the PHLX. First of all can these options be used for a non-US dollar pair (e.g GPY/JPY or NZD/JPY) or is it only in relation to a pair with the USD?

Secondly what is the actual mechanism and liquidity of these options? ( I m not talking about the actual option greeks etc but rather the practicalities of the option purchase as i presume it would need some special arrangement between your forex bank/ Broker in order to co-ordinate the entire transaction.)

I m pretty sure that the big players..or rather (the folks that really know what they are doing!!) are hedged in the carry trade....I know that we hear a lot of ha hu about the unwinding of the carry trade day in day out for the last week or so on CNBC and other news wires.......its only the panic unwinding of the position from the guys who have not a very good idea what they are doing......the big players in the carry trade don't really care which way the market moves...as long as the interest are not equal. (thats what I ve concluded anyways!!) coz they know which way the market moves..they make money!!!!! ( those are the people I refer to as the 5% club!)

I guess what I m referring to here is the use of a Dynamic Hedge in stock trading in the Forex or any variant of it...

One last question I would like to know if you know the answer to the above is would the premiums paid for the usage of such options eat up the interest earned. Somebody did "indicate" to me that he believed the option premium would probably eat into the interest earned but he wasn't sure.....

So any handy hints on the above would be greatly welcomed......or even if anyone passing by has any info on any educational resources I can refer up on the matter I would be greatly appreciative....

Many thanks for your time...
  • #3
  • Mar 11, 2007 6:24am Mar 11, 2007 6:24am
If the premium is more or less the interest you earn, a good strategy for people who can't earn (or who lose money) in forex would be buy gbp/jpy for example in spot market and hedge it with options for 3-6-12 months. If the pair goes up you earn money, if not you don't lose money. But the interest earnings must be as much as the premium cost or not too different. If so if you made trades for 3 months is not difficult to get some profit in a year.
  • #4
  • Mar 11, 2007 12:10pm Mar 11, 2007 12:10pm
This doesn't make sense.

If the premium is equal to the swap, how would you make money? Provide a concrete example with your math, because I'm not sure this statement is valid.

If you sell a put, then your profit is:

profit = strike price - premium - current price at expiry

right?

A long position in the spot market is going to be:

profit = current price + swap - buy price

if your strike price and buy price are equal, then your hedged profit will be

hedge profit = (current price + swap - buy price) + (buy price - premium - current price at expiry)

Assuming that the current price = current price at the expiry, then:

hedge profit = (current price + swap - buy price) + (buy price - premium - current price)

and

hedge profit = swap - premium

therefore, if the swap is LESS THAN OR EQUAL to the premium:

hedge profit <= 0

hedge profit = A LOSS

so, this makes no sense UNLESS the accumulated swap is GREATER THAN the premium.

Care to try and explain where I might be wrong?

Quoting jon167
If the premium is more or less the interest you earn, a good strategy for people who can't earn (or who lose money) in forex would be buy gbp/jpy for example in spot market and hedge it with options for 3-6-12 months. If the pair goes up you earn money, if not you don't lose money. But the interest earnings must be as much as the premium cost or not too different. If so if you made trades for 3 months is not difficult to get some profit in a year.
  • #5
  • Mar 11, 2007 1:23pm Mar 11, 2007 1:23pm
Example:

GBP/JPY is at 232.00 on 03/01.
Long in spot forex and short in options for 3 months.
GBP/JPY @ 220.00 on 06/01.
Forex: -1200 pips + swap.
Options: +1200 pips - Premium.
Total: 0 (swap=premium). You simply lost the spread and comissions, 10 pips for example.

On 06/01 you repeat the two trades.
The pair is at 200.00 on 09/01. Total: 0.

From 09/01 to 12/01: 218.00
Forex: +1800 pips + swap.
Options: 0 - Premiun.
Total: +1800 pips.

From 12/01 to 03/01: 190.00. Total: 0.

Result for the year: +1,760 pips (1,800 - 40 pips spreads and comissions).

If 95% of retail traders are losers this strategy would be good for them. If all trades are losers on spot forex you just lose 40 pips but what if you win the 4 trades?
  • #6
  • Edited 5:26am Mar 12, 2007 5:14am | Edited 5:26am
Hi there Jon167

I am currently contemplating joining Ikon GM for options/futures trading. Could you perhaps suggest another one for me to test out. Ikon is nice and have a nice platform, their spreads are bit high though and the platform eats bandwidth like a starved caterpillar.

By the way, your explanation about using the swap to pay the premiums makes 100% sense and it is very low risk. One could actually set up similar trades at the end of each month and eventually will have a continues chain of open trades protected by options and using the swaps to pay the premiums. For those who do not understand this just be extra wary that it will probably not work with pairs like GBPUSD because of the small interest differential…perhaps USDJPY, bottom line, the magnitude of the differential would imply for how long to date your options.

I’m looking at a delta neutral system again ( long the spot, hedge with fixed amount of options ) adjust the spot size from time to time, collect the swaps also and hopefully come out in one piece the other side LOL, would love to discuss these kind of strategies as opposed to trading the spot on it’s own.

Best wishes, and please let me know some broker options if you can.

Mecer
  • #7
  • Mar 12, 2007 5:40am Mar 12, 2007 5:40am
Quoting jon167

From 09/01 to 12/01: 218.00
Forex: +1800 pips + swap.
Options: 0 - Premiun.
Total: +1800 pips.

?
Jon, could you please explain this part of the scenario a bit. How is it that you can have +option pips, but not negative?
The market is my nation. Traders, my family. Hello, brothers and sisters!
  • #8
  • Mar 12, 2007 6:21am Mar 12, 2007 6:21am
Bear in mind the above was done assuming the premium on a put is more or less equal to the net swap rate for the life time of the option – which in actual fact it is not, swap is more or less 50% of the premium only. The only way to isolate the swap would be to setup up a synthetic long or short i.e. synthetic short gpb/jpy = long put + short call

When you deduct the long put premium from the received short call premium we are left with more or less the net swap rate for the life of the option. Trouble is, a synthetic long or short has no different risk profile than a simple long or short spot, unlimited loss and unlimited profit.

With this in mind, it I suppose the suggested method is not practically executable.

For example, I just pulled live quote for the GBPJPY Apr,May & Jun contracts with the premiums of $2870, $3857 & $4555 respectively for a $100k contract. Interest received on a $100k spot is about $26 per night and thus on it’s own can never cover more than about 50% of the premium over the life of the option on it’s own. At best the received swap serves to reduce the break even of a basic long spot/long put spread by about 50%.

Mecer
  • #9
  • Mar 12, 2007 6:30am Mar 12, 2007 6:30am
Quoting Mecer
Bear in mind the above was done assuming the premium on a put is more or less equal to the net swap rate for the life time of the option – which in actual fact it is not, swap is more or less 50% of the premium only. Mecer
Of course. The numbers were assuming that swap=premium. If not ...
  • #10
  • Mar 12, 2007 6:46am Mar 12, 2007 6:46am
http://www.riskglossary.com/link/tim...nsic_value.htm
  • #11
  • Apr 5, 2008 10:04pm Apr 5, 2008 10:04pm
Quoting Mecer
Bear in mind the above was done assuming the premium on a put is more or less equal to the net swap rate for the life time of the option – which in actual fact it is not, swap is more or less 50% of the premium only. The only way to isolate the swap would be to setup up a synthetic long or short i.e. synthetic short gpb/jpy = long put + short call

When you deduct the long put premium from the received short call premium we are left with more or less the net swap rate for the life of the option. Trouble is, a synthetic long or short has no different risk profile than a simple long or short spot, unlimited loss and unlimited profit.

With this in mind, it I suppose the suggested method is not practically executable.

For example, I just pulled live quote for the GBPJPY Apr,May & Jun contracts with the premiums of $2870, $3857 & $4555 respectively for a $100k contract. Interest received on a $100k spot is about $26 per night and thus on it’s own can never cover more than about 50% of the premium over the life of the option on it’s own. At best the received swap serves to reduce the break even of a basic long spot/long put spread by about 50%.

Mecer
hello,

here is something i saw as a posisblity but not completley risk free...
buy the gbp/jpy spot at say 200.00, buy th2 gby/jpy put for say 1.85 expring 7 days later (on a Friday), simulateansouly seel the 200.00 gby/jup call (expiring on the folowing Monday>..the rremiium for the call covers the premium padi for the put (and ocassionaly a pip or two more) and collect swap interest risk free until the put expires on the following Friday...have I done it? yes, but the broker I used i used just diwdened the spreads on the this pari from 12 to 20....it's tough finding a good reatils fx/fox options broker.

now, for the skeptics...on expiry of the put i find the gby/phy has usually moved a couple hundred pips eiether way..if it's below my put strike price, i get the case difference and close the long positions at the 10:00 a.m. new york cut time...the short call will then expire worthless on the folowing MOnday morning...the key is the fact that i recfeived more premium for the short call because of the differenc ein expridy dates but there is of course no trading over the weekend so unless i get whipsawed i am fine...coments welcome
  • #12
  • Sep 11, 2008 2:24pm Sep 11, 2008 2:24pm
Does anyone made this work? a little update will help on this matter.
The market can stay irrational, longer than you can stay solvent.
  • #13
  • Apr 30, 2009 1:48pm Apr 30, 2009 1:48pm
what would be best carry trade to do right now? euro/try ? does anyone know if spread betting brokers charge intrest on holding position for few months?

thx
  • #14
  • Last Post: Apr 30, 2009 6:56pm Apr 30, 2009 6:56pm
The extrinsic values of the options WILL be greater than the interest you can earn in the spot market! Sorry, no free lunch there, especially considering that volatility is through the roof now.
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