Читать книгу FX Option Performance - Peter Billington - Страница 9

This information has potential to be of use to a wide variety of market participants. One way of looking at it would be to think of option suppliers (sellers of risk) and option consumers (buyers of risk). The former might be balance sheet holders who can sell a ‘covered option’ – essentially, if they hold the underlying currency, they can make money by selling an option which pays out if the currency rises but not if it falls. If it rises, their holdings will increase in value so they can pay the option holder. If it falls, they do not have to pay but they collect the premium. The option consumers have unwanted currency risk they need to reduce, like an investor with an international portfolio of bonds, or a corporation selling goods in another country. Additional to option suppliers, there are market makers like the option desks of larger banks, which both buy and sell options to make a profit from the bid-offer spread. Also there are purely profit-focused entities, like hedge funds, which take views on direction or inefficiencies in the market to make money. Finally the world's central banks can direct massive FX flow, sometimes using options, to execute policy aims like currency strength or weakness. And each of these has properties of the others; a portfolio manager may wish to protect against currency risk but derive some return, and even a central bank may maintain a trading arm to smooth volatility and influence currency levels.

The accounting and regulatory bodies additionally maintain a strong interest in the use of FX options, and could be interested to learn that in some circumstances simple options can be more useful than forward contracts. Thus a wide range of market participants from central banks to hedge funds, investment banks to insurance companies, corporations to pension funds could find much of interest in the data we present.

Perhaps the most useful division of FX option traders is into two broad categories: those who wish to protect against losses due to foreign exchange movements, and those who wish to make money from those same movements. We can call them the hedgers and the investors, while understanding that most trading entities contain both types to some extent.

1.4.1 How Hedgers Can Use This Information

A good example of a hedger would be a European corporate which sells cars to the United States (US). Assuming they have no manufacturing capacity in the US, then their expenses are largely in EUR while a large part of their income will be in USD.9 If the value of the USD falls relative to that of the EUR, their income will drop but their expenses will remain fixed. Thus they would possibly like to insure themselves against this eventuality.

Such insurance will naturally be temporary in nature; one could insure for a period, but eventually it will expire and the company will be left with the new exchange rate to deal with. But what can be covered are sudden price jumps over the period, so that at the end of the year (if the period is a year) the company can take stock and plan the following year with some confidence.

So it will be useful to be able to protect against sudden damaging drops in the value of the USD. But it would be good for the company if sudden rises in the value of the USD, which would be beneficial, could nevertheless be taken advantage of. These two facts are important to the company's decision of whether to hedge the risk.

Clearly an option, with its asymmetric payoff, will be of interest in this situation. If the company could be reasonably confident that the option offered good value for money, then it would be the obvious choice. However, in general, the company will simply not know whether the option is good value. It is often assumed that because options are more complex than forward hedges they must be much more expensive. So if we can show that under some circumstances options have historically not been expensive, the corporates which currently avoid them would be interested to take another look.

Of course payoff is not the only factor to consider when choosing a hedge strategy. A forward hedge will reduce overall volatility, as it is in some ways simply the opposite exposure to the hedged quantity. So if this is important, the forward rate will have an advantage.

Additionally, for a hedger the evolution of the underlying is critical. Many corporate hedgers already effectively have an FX position – our European car manufacturer mentioned above might buy a protective option and never need it, with the money spent on the premium being lost. But, if the USD has appreciated several percent in the period, they will have made money overall. Conversely, a sophisticated hedge programme might sell a few short dated call options on the EURUSD rate, reasoning that if it moves in their favour (decreasing rate in this example) then they will make money and can cover the option payoffs. Their reasoning may be that if the rate moves mildly against them then they will pick up some mitigating profit from the option premiums – but this will not help them much if the rate move is large.

Finally, accounting and tax treatments will play significant roles in the choice of hedge strategy and tend to favour forward contracts. Perhaps if the historical behaviour of options were more widely known it might have an effect in these very different circles.

1.4.2 How Investors Can Use This Information

The word ‘investors’ covers a wide variety of market participants; we list a few below:

• Insurance companies

• Hedge funds

• Pension funds

• Mutual funds

• High Net Worth individuals.

The investors will want to make money. They are motivated to use money to make more of it. Thus they will buy an option if they have reason to believe that the payoff will be larger than the premium, and sell it if the opposite is the case.

Short10 dated option selling uses the fact that, in some markets, the investor believes that the premium is too large given the risks in the market (more of this later…). A truly classic example of this would be in the aftermath of a high risk period. Shortly after the market shock caused by the Lehman bankruptcy in the autumn of 2008, FX option volatilities remained very high for some months. They were implying that markets in the future would be choppy and very active. Essentially, they were reflecting the views of nervous and shaken market participants that the market was in a state of high risk. In fact, the months following the 2008 crisis were consistently less volatile than implied by the option volatilities; selling options would have been very profitable. In Figure 1.2 we show the cumulative result of selling one-week EURCHF options each week between 1998–2013. We chose EURCHF as an example here to include a currency pair which had periods of very low and very high volatility. It is easily seen that the investor who correctly judged when the market was overestimating the future risks would have made strong returns – but it would have taken nerves of steel. A misjudgement could have seen sharp losses, which would have been almost impossible to avoid as liquidity was at times non-existent during this period.

FIGURE 1.2 Cumulative returns in percent of notional to a 1W short put strategy in EURCHF

Anecdotally, many hedge funds do make money by selling volatility in this way. ATMF options might not be the contracts of choice; they are liquid and have relatively large premiums, but the investor might want to collect a larger premium with a more complex structure, or might want to make a payoff less likely by choosing an out-of-the-money option – see Chapters 5 and 6 on these. But the principle is the same: selling volatility makes money when the market overestimates future risk. However, this route to profit is paved with disasters. Many a hedge fund has seen literally years of steadily accrued profits evaporate in a day or two of crisis-driven market action. We see this in Figure 1.2; though the option selling strategy ends up in profit, the losses or drawdowns can be huge and sudden.11 The data set finishes in 2013, but one can imagine the effect of 2015 events when the currency peg was removed by the central bank.

The other way that investors in general trade option markets is to buy options which they believe are undervalued – the idea behind Naseem Taleb's famous ‘Black Swan’ fund [3]. This type of strategy seeks out markets where risks seem to be underestimated and buys options which will pay out handsomely if this is true. Consider a longer dated option, say for 12M, bought in the spring of 2008 on USDJPY. The investor might have reasoned that problems surfacing in the US housing market would sooner or later cause a sharp depreciation of the USD – and they would have been right. Buying an option with a longer tenor allowed them to make money even though they were uncertain of the precise timescale.

So clearly there is much of interest in systematic differences between premium and payoff for the investor community. However, we said that there is no magical formula for trading strategies within these pages. Why not?

Once one considers how trading strategies would be executed, it becomes possible to understand how inefficiencies are not necessarily pots of gold at the end of financial rainbows. Imagine we identified a strategy which said that selling options of a certain type could result over time in a profit. We know, however, that sold options have unlimited loss potential, so even if the result after a few years was likely to be profitable, the risks in between could be enormous. The investor might have to tolerate a loss of 20 % in one year to average a 5 % return over several. That's not a very good risk/reward ratio on your investment. Or perhaps one might identify an opportunity to buy options and make money. In this case the risks would at least be limited, but what if the options were long term and only made money near the end of their lives? The investor would have to fund a loss for some time before it was likely he would see profit. Given that the strategies would only be expected to make money over a number of years, with profit and loss in between, there would always be a risk that in any one year they would be unlucky. In short, while we hope this book will inform investors about likely areas for further investigation, as we said before, there is no magical recipe within these pages.

Finally, investors often buy overseas assets which have good return potential. In this case they may wish only to have exposure to the asset itself, and not to accept the FX risk. In this case they turn back into hedgers and may find utility in this book as previously discussed.

9

When referring to currencies we will use the three-letter ISO codes, so EUR for the euro and USD for the US dollar. A table is given in the Appendix.

10

Short dated contracts in FX usually refer to anything up to 3M tenor. Long dated would be 1–5 years.

11

It is worth a quick note on returns and leverage. The graph gives returns in percent of notional amount. However, this is not the same as capital invested, as no more than a few percent of the notional amount is ever needed or risked. So to make a comparison with this and an equity investment, it is common to specify capital ‘at risk’, which, looking at the graph, might be considered to be 20–30 % of the notional amount. Thus the returns would be multiplied by a factor between 5 and 3 in this case.