Question

Given the following data, detail the hedging strategy using Options Contracts

Net Exposure €50,873,878

Contract: Euro September $1.25 Puts @ $.0255/Euro

Size: 125,000 Euros

Spot rate: $1.2307/ Euro

6 month forward rate: $1.2485/ Euro

Answer 1

Hi,

Net exposure is in Euros and company which has an exposure should be an US based company..

Strategy 1:

We can enter a forward contract to mitigate the exposure of 50,873,878 Euros in six months. This would have the effect of locking in an exchange rate equal to the current forward exchange rate i.e @ $1.2485/ Euro

Strategy 2:

Long a PUT option, Premium = (125,000 * 0.0255) = 3187.5 Eur

Buying a PUT option gives a right but not obligation to sell @ 1.25$/Eur, so this would provide insurance against weak EUR but still alllowing us to benefit from a Strong EUR.

One lot covers 125,000 * 1/1.25 (just converted strike from $ to EUR) = 1,00,000 Euros

So to cover exposure of 50,873,878 Euros we need to Buy 509 Contracts of Put options.

Hope that helps.

Regards,

Bala