Hedging foreign currency values is one of the trading strategies. This strategy makes it possible to keep trading risks to a minimum and prevent the results from being influenced by wrong decisions in the past. Also, this technique allows you to correct errors caused by wrong decisions about buying or selling options. This is one of the most popular money management methods.
Trading Strategy with Currency Hedging
Example of hedging
For example, at 10:00 you buy a call option for EURUSD at a strike price of 1.3600 for $100 with expiration at the end of the day (24:00). In case of a successful outcome (the price at midnight will be higher than 1.3600), the payout will be 170% or 170 $.
Otherwise, you receive compensation in the amount of 15% or 15 $. At 17:30 the EURUSD price reached 1.3700.
If you believe that the next move could change its direction, then it's time to buy a put option at the same price and with the same expiration time at the new strike price (1.3570). So, we create a corridor where the price will move. This kind of action is called hedging on a currency pair.
At the end of this situation we have three possible outcomes at 24:00:
- EURUSD price is lower than 1.3600 - the first call option loss, the second - win. The total payout is $ 185. The total investment amount is $ 200. As a result - the loss of two trades is 15 $ instead of 85 $.
- EURUSD price is between 1.3600 and 1.3700 - both options worked.
The total payout is $ 340. The total amount of investment is $ 200. As a result - a profit of $ 140!
- The price of EURUSD continues to grow and at the expiration time is higher than 1.3700 - the first call option wins, the second loses. The total payout amount is $ 185. The total investment amount is $ 200. As a result - the loss of two trades is 15 $ instead of 85 $.
Practical explanation of Hedging
So, as you can see: two variants can bring a disadvantage and only one advantage. Let's look at this situation again. Before making any trade you need to check the market behavior and not to trade when this is not a good time for this. Buying the second option makes sense only if the price reaches a certain support/resistance level, or a certain event or news causes a sudden change.
Generally, in such situations most often you can see the price correction in the opposite direction. So you will be able to gain more often than you lose.
Also, we can hedge the currency risk by using options for the asset, which differs from the main one, which was used for the first insured trade. There are many assets, where prices move simultaneously or in opposite directions.
In other words, if you buy call options for EURUSD, then you can reduce risk by buying put options for USDCHF because these pairs usually move in unison. There are also a number of cooperating/competing companies, whose share prices are either driven by one or the other.
So, it turns out that with the help of risk hedges, including financial, when the market requires or you make a mistake, you can minimize possible losses and significantly increase profits, and profits are almost 10 (!) times higher than potential losses.
Posting Komentar
Posting Komentar