Hedging Advice

Praetorian · Post by **Praetorian** » Wed Jan 23, 2013 6:25 pm

I trade a portfolio in US$ but my local currency is €, therefore I hedge the portfolio with fx futures that I roll over. If the PnL in US$ is high enough, I buy more futures to hedge the residual. Unfortunately there seems to be much more to hedging than implementing it this naive way.

Can anybody give me personal advice or a good book/paper reference discussing in-depth some hedging problems? I am specifically interested in the following detail problems:

- Hedging instruments (Futures vs. Options vs ETFs? vs XXX)

- Tax considerations

- Cashflow Hedging

- Coping with Interest rate risk and basis risk resulting from hedging with Futures

- Measurement of hedge effectiveness

My main concern is the cheapness of the hedge, meaning minimizing margin requirements and bid/ask spreads. The hedge should also have a very small hedging error at end-of-month (my reporting frequency).

granchio · Post by **granchio** » Wed Jan 23, 2013 6:57 pm

maybe dumb question: is there a reason you use futures? why not simply cash forex?

Praetorian · Post by **Praetorian** » Wed Jan 23, 2013 7:10 pm

I use IB as a Broker and my account currency is USD. As far as I know I can not do cash forex transactions there with leverage employed, right? If I understand it right, then cash forex is not capital efficient.

Luciender · Post by **Luciender** » Wed Jan 23, 2013 7:25 pm

Why not? Spot eur/usd at 40:1 with IB is a bit less efficient than the future but you should be able to. Rolls will be a bit more expensive too.

Praetorian · Post by **Praetorian** » Wed Jan 23, 2013 7:32 pm

I just discovered that they support leveraged cash fx Big Smile . I only knew about their Forex Conversion products so far. Thanks granchio and Luciender! The leverage of 40:1 should suffice, perhaps they reverse it some time back to 50:1.

@Luciender: What do you mean that Rolls will be more expensive? If I use Forex leveraged I have to roll? When does a Forex Leveraged Contract mature?

Luciender · Post by **Luciender** » Wed Jan 23, 2013 7:55 pm

Daily at 5pm EST your fx position will be rolled to the next spot date. You can google "tom next" for more info on the details. NZD and RUB have different a convention, IIRC.

IB applies a small spread on the rates(depending on your tier), while with the future the carry should be more competitive.

Praetorian · Post by **Praetorian** » Wed Jan 23, 2013 8:30 pm

Their interest rate spread seems to make cash forex hedging with daily rolling rather expensive, even in the higher tiers. Despite the rate spread, do they also charge the bid/ask spread on spot fx when they roll?

I think I am stuck again with my initial questions Head against Wall

Lightning · Post by **Lightning** » Wed Jan 23, 2013 9:52 pm

Has been a long while since I have been involved with this but you might want to tap some Hedge Fund individuals where they have fund feeders in various CCYs, and (often) are looking to minimise the differential between the returns of the various feeders (ie mitigate FX effects). They might have a better or more refined solution or give you a barometer for when you should 'top-up' your hedge.

From what I recall we (Equity L/S HF) employed something similar to what you are describing, but as you say it costs money and I can recall when the market was going nuts in 2007/2008 it was a real challenge to do properly.

To the 'why not cash FX' question its a margin thing i would have thought? although from responses above seems IB has come up with a potential solution...

granchio · Post by **granchio** » Thu Jan 24, 2013 12:37 am

i guess you are talking about unrealised P&L (or you wouldn't need any leverage... just convert the hard earned $)

then yes, IB does charge some serious spreads. maybe you can save a bit by doing futures etc, but you get into other risks as you mentioned. might be easier to keep it cash - at least you know the costs upfront

eläin · Post by **eläin** » Thu Jan 24, 2013 7:54 am

I face the same issue and have chosen not to hedge at all. I believe that in the long run time spent on true pnl effort has a larger positive expected value (even before accounting for the cost of the hedge). In other words: profit enough and fx movements will become noise.