GBPUSD pair as a hedge

hi guys, i have a question. let say you are living in the UK and you are thinking of buying shares of a US-based company, and your allotted fund for that is £10000(~$15709.43). of course, this US company shares is quoted in USD.

how would you position-size your GBPUSD pair as a hedge so that when the time comes and you decided to sell the shares of this US-based company, the profit is not adversely affected by the currency exchange rate? how much is the lot and £/pip for this pair? can you please enlighten me?

thanks very much.

any ideas guys?

tnx

I'll take a stab at this...

Your "risk" (other than the stock losses) is that any profit will be offset by a falling dollar.

Ex: if GBP/USD is currently 1.55 and you invest 10,000 GBP you are investing 15,500 USD. If you make a profit of 5% you will have a total of 16,275 USD. If in the same time GBP/USD rises to 1.60 your profit shrinks to 10,172 GBP, or just 1%.

The exchange rate has taken 80% of your profits! So to hedge you would also want to place a long at twice your stock investment (2 minis) to offset the 1,000 USD you lose on the exchange.

This strategy also has a down side. That is that the exchange rate goes the other way...You make more money when you cash out your US Stock but that extra is eaten away by the losing hedge.

You'd have to put some real numbers on paper and look at the currency trends to see if this would work...time is another factor to be considered...how long you plan to hold the initiating investment...where the currency exchange goes...or looks like its going...

Hedging usually means "guaranteed loss" on one side or the other.

Yeah I think he's aware of the problem ... you can't tell how much GBP/USD you need to sell to protect the $$$ profit ... figures would be different for $100, $1000 etc. Note, not $1000 investment but $1000 PROFIT. You don't know the profit in advance do you?

Hedging always means a guaranteed loss on one side but that can also save your ass - I know someone who hedged his CHF forex mortgage before the recent franc appreciation, his monthly rates (in his local currency) went zoink off the scale but he made the same profit on the hedge so he's quits while many others have to skip meals just to pay the rates. Every tool has its use they say ...

Of course the worse case scenario (a very REAL scenario) is that the stock position looses and the long GBP/USD also looses. That would really suck!

Thinking about this some more perhaps it would be possible to buy a put option on GBP/USD that can be done for much less initial cost. That way if the GBP/USD falls you only loose the option (a much smaller risk) and if the GBP/USD rises you have an established position in the market that can then be managed for risk against any gains/losses on the stock position...Just a thought

hi gspajon, you've got a valid point and i take that on-board. thanks.

hi spekitox, do you have any idea how he did that? how he position-sized his hedge? thanks for any ideas, suggestions.

I'll ask him, I know he had some leveraged EUR/CHF trades but also spent his excess cash on buying insane amounts of currency ...
that was the first and so far the last time I saw a CHF 1000 note, ohh, cash is king, you can fold it you can smell it, and it's crispy, none of these true for plastic cards LOL

There is a halfway house where you hedge the original investment only. After all you know that amount for certain. Obviously any profits are subject to currency fluctuations but it may be better than nothing.

If you are really brave and you have a TP in mind for the equities you could hedge that instead but if it goes against you it could turn nasty.

Anyway this was an interesting little problem and I put together a spreadsheet to crystallize my thoughts. It may be of interest so I've attached it. Enter the four figures in column C and it works out the positions for hedging both the original and projected TP amounts.

At least you have the option to explore the various alternatives and their outcomes, good or bad.

It seems to hang together but as ever it comes without any warranty and you use it at your own risk!! But then you knew that anyway I guess.

David

hi davidb, thanks very much for that spreadsheet, that's ace. i think that's a useful tool. by the way, you mentioned something about "halfway house", can you tell me the its name please? thanks a lot again.

Ooops, my apologies, I shouldn't use local English sayings in an international forum - they don't travel well.

A "halfway house" isn't anything physical, it's an English saying that refers to a position between two extremes.

What I was trying to say was that as well as the two positions of hedging nothing and hedging everything including any profits there is also a halfway position where you can just hedge the original capital invested in the equities.

Sorry for the confusion!