Is there a good way to hedge out the currency risk associated with receiving a Swiss franc salary as an expat? I have painfully watched my salary in USD terms decline about 20% since starting to work this spring and worried there could be more depreciation of the CHF to come. Obviously the portion of compensation that I spend locally is fine, but I assume like most expats I have bills back home to pay and savings which I ultimately plan to use in the US. So would ideally like cheap way to hedge out currency risk on future cash flows that I plan to use or save back home.
I hope this is not too obvious or discussed elsewhere, but what are the options? My understanding of the only approaches are:
-Use futures market. The problem is that one contract I see is CHF125,000 – more than I could easily do and this market seems to be more setup for firms or people moving around lots more money than I plan to have.
-Use options. Buy puts on FXF (or similar) to protect against depreciation of CHF. This gets costly though, so would balance cost and get rid of upside by selling FXF calls. More granular than futures but right now can only get options out to Jun-09.
None of this sounds particularly easy or fun to do on a continual basis. There must be easier way. Interested in hearing other people’s approaches, recommendations, or any good threads/resources that discuss the options.
You could open a trading account with Oanda, They accept small accounts (few hundred dollars) and not only can you hedge but you can do it at leverage. They offer 1:1 up to 1:50. It does of course, carry risk. I believe this dollar rally may be finished and has already started to decline. Thats one idea.
futures are normally marked to market... you do not pay the nominal value, only the positive or negative difference at the end of each day. For example, you buy a future, pay nothing. if that future appreciates in value by usd 100 by the end of the day, then usd is deposited into your account. if the next day it depreciates by usd 200, then usd 200 is debited. you should have enough margin to be able to cover shortfalls. however, i do not recommend that anyone trades financial futures of any type unless they are pretty confident about what they are doing.... generally speaking futures are a tool for market professionals. given the volatility which we see daily in this climate, there can be massive swings for and against... this could very quickly cause you a new set of problems.
if you are that worried about the depreciation of the chf, then ask your bank if you can open a usd account. they wont do it for small amounts, but i think that in the amounts you are talking about, its likely that they will oblige.
Spot on krlock. Currency hedging isn't straightforward for the man on the street who is looking to hedge small amounts. For the small saver, I'm not aware of any cheap, efficient way to hedge future cash flow. As you suggest the easiest and cheapest way is to convert spare cash into dollars in the spot market as and when it becomes available thus achieving an "average FX rate" over the course of the year.
Where's the risk with a future's contract? It's just a forward sale of CHF vs $. You know exactly, up front, what FX rate will be used down the road when you enter into the contract therefore you are immune from currency fluctuations in the meantime. You are only at risk only if you do nothing. Of course if the CHF doesn't depreciate as you feared then you may have been better off not doing the currency protection in the first place but that's the price of entering into a forward sale.
Not what I was getting at, but true. However initial and daily variation margin rules are there to limit that exposure and if you trade on a recognized bona fide exchange, a small risk? Private forward contracts another matter entirely.
The mini futures, that I refer to, are leveraged. The buyer pays 10 or 20% which is actually the margin call. Hence, there is a leverage of about 5:1 or 10:1. If the bet goes the wrong way, and the investment is burnt up, then the issuer liquidates without asking for more margin.
To my mind, you are confusing a futures contract with a forward contract. A forward contract locks in a rate for standardised block of something on a future date but agreed now. A futures contract is free to fluctuate. You "get into it" where the market has a current fair value, in other words where the market participants think it is currently worth.... but there is plenty of risk for daily variations.
Certainly not a tool for an amateur. As they are also often leveraged that makes them especially dangerous. For example, one DAX future moving one point in your favour will earn you 25 euros. Ok fine, lets buy 25 dax futures. If you had bought them at the high of the dax earlier this year and sold them now (assuming you had the margin to cover it!) your pockets would be lighter by more than 2m euros.
Not so. Futures contracts are marked and settled on exchange against random counterparties and guaranteed by a clearing house. Unless all counterparties go bankrupt, then futures contracts have negligible counterparty risk.
No. In terms of economic risk, which is what I was talking about, a forward sale or long asset/short futures position is essentially the same. There are differences in the mechanics in terms of cash flows, settlement and counterparty risk but in terms of locking in an effective exchange rate and hedging out further downside the result of the two strategies is essentially the same when the forward contract delivers or the futures contract expires and the hedge position is unwound. In that context, one point I didn't make, the OP was talking about hedging future CHF receipts. He would have to be certain those cash flows materialise otherwise he might find himself with a naked short position which would carry full economic risk.
That's why it's important to understand where the mini futures contracts are traded/issued in order to assess the counterparty risk which Shorrick pointed out. If they're traded on a major exchange that's one thing but quite another if they're repackaged big futures contracts which are chopped up and sold on to retail investors by an issuer of a structured product.
What's the problem with leverage? If you are shorting futures as a hedge and short only enough contracts to give equivalent market exposure to your long position then what's the problem? You're market neutral.
The OP isnt talking about being long asset short futures. of course that can be delta neutral, though not necessarily. He is suggesting to use a futures contract against CHF. that isnt delta neutral at all.
A future is a future. If something is cut up and repackaged, it is a structured product. They are not the same thing. Counterparty risk on futures is negligible. Counterparty risk on structured products is of course another thing entirely.
The problem with leverage is that for inexperienced non market professionals they can very quickly lose control of their position. As an options and futures trader who has traded hundreds of thousands of futures, I have seen plenty of "market neutral" positions over the years, including some of my own, which turn out to be quite the reverse.
Naturally though this is exacerbated by the use of options rather than delta 1 products. Nevertheless, hedging isnt always as straightforward as people imagine, and certainly not for beginners. Using the dax future example i used earlier, if you are long the index in cash and hedged by shorting a dax future, then because the future is leveraged, for every point that the underlying index moves, you are effectively leveraged at 25 times that rate in your hedge. Therefore, you need to long 25 times the amount of cash to be properly hedged, or you need to dynamically hedge your position on a variable basis. Thats just one example.
In conclusion, as the OP did not realise that you do not pay the nominal for a futures contract, he clearly isnt likely to be an experienced trader of futures or other derivative market instruments. Therefore I would suggest that the use of such instruments are not especially suitable for him. Thats more or less all i was trying to say.
Have it your way krlock3. I'm not going to enter into a debate on this. But if you don't put the correct hedge ratio on in the first place I can see how a position could run away with you.