Instead of buying a foreign stock index, you can buy futures and options on the foreign stock index and then you can choose to hedge the option premium or the future margin if so desired. My question is how is this any different from direct currency hedging where you buy the foreign asset directly and buy a currency put option to hedge currency risk. I can see that the absolute $$$$ in the investment strategy would be less, but can’t get past that point. Any clarification would be much appreciated.
There is less hedging required if you only have to hedge the premium on the index option (or the futures margin) as opposed to the whole index.
I think the difference lies in that with Direct you would hedge buy buying derivatives on the actual stock itself as opposed to dealing with indices. Which i think is what you are saying also. Indirect is also used (besides less expansive as you mention) when there may not be a way to hedge your foreign asset exposure. (i.e. No options on the individual stock) I think it’s similar to Proxy Hedging in that you do it because it’s the best alternative to not having a real direct solution to hedging. Make sense, or am I confusing things?
McLeod81 Wrote: ------------------------------------------------------- > There is less hedging required if you only have to > hedge the premium on the index option (or the > futures margin) as opposed to the whole index. Why would you hedge the premium of an option you are buying to hedge your position? Did I miss this in the curriculum? I think the point is buying an option is cheaper than replicating the index, but you wouldn’t then hedge your premium, right?
LPoulin133 Wrote: ------------------------------------------------------- > McLeod81 Wrote: > -------------------------------------------------- > ----- > > There is less hedging required if you only have > to > > hedge the premium on the index option (or the > > futures margin) as opposed to the whole index. > > Why would you hedge the premium of an option you > are buying to hedge your position? Did I miss > this in the curriculum? > > I think the point is buying an option is cheaper > than replicating the index, but you wouldn’t then > hedge your premium, right? You are using an option to get foreign access exposure here, not to hedge. By using the option it automatically exposes you to less currency risk (kind of indirect way).
LPoulin133 Wrote: ------------------------------------------------------- > McLeod81 Wrote: > -------------------------------------------------- > ----- > > There is less hedging required if you only have > to > > hedge the premium on the index option (or the > > futures margin) as opposed to the whole index. > > Why would you hedge the premium of an option you > are buying to hedge your position? Did I miss > this in the curriculum? > > I think the point is buying an option is cheaper > than replicating the index, but you wouldn’t then > hedge your premium, right? The premium is what is subject to FX risk, correct?
mwvt9 - I see, I was confusing concepts. ptmf - Yes, I think option premiums are exposed to translation risk.
Thanks everyone. Very useful discussion.