InvestorQ : I am positive on the US dollar strengthening but I also want protection in case the dollar weakens. What can I do as a currency strategy?
Arti Chavan made post

I am positive on the US dollar strengthening but I also want protection in case the dollar weakens. What can I do as a currency strategy?

Answer
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Mahil Khan answered.
1 year ago


One way is to buy a call option on the US Dollar so that your downside risk is limited to the premium paid. Alternatively you can also create a synthetic call by combining a futures and a put option in the same strategy. For example, if you expect the dollar to strengthen further versus the rupee, you can buy the USD-INR futures at Rs.72 and also simultaneously buy a 72 put option on the USD-INR strike 72 at a premium of say Rs.0.30. How will the payoffs look like in this case?

Buy Futures

72.00

Prem

N.A

Strategy

Synthetic Call or Protective Put Option

Buy ATM Put

72 Strike

Prem

0.30

Buy 72 Futures and 71 put

Break Even

Once option cost is covered over the cost of Futures

Price

Buy Futures

Put Strike

Put Premium

Break Even Cost

ITM / OTM

P/L on Futures

P/L On Put

Sell Put P/L

68.00

72.00

72.00

0.30

72.30

ITM

-4.00

3.70

-0.30

68.50

72.00

72.00

0.30

72.30

ITM

-3.50

3.20

-0.30

69.00

72.00

72.00

0.30

72.30

ITM

-3.00

2.70

-0.30

69.50

72.00

72.00

0.30

72.30

ITM

-2.50

2.20

-0.30

70.00

72.00

72.00

0.30

72.30

ITM

-2.00

1.70

-0.30

70.50

72.00

72.00

0.30

72.30

ITM

-1.50

1.20

-0.30

71.00

72.00

72.00

0.30

72.30

ITM

-1.00

0.70

-0.30

71.50

72.00

72.00

0.30

72.30

ITM

-0.50

0.20

-0.30

72.00

72.00

72.00

0.30

72.30

ATM

-

-0.30

-0.30

72.50

72.00

72.00

0.30

72.30

OTM

0.50

-0.30

0.20

73.00

72.00

72.00

0.30

72.30

OTM

1.00

-0.30

0.70

73.50

72.00

72.00

0.30

72.30

OTM

1.50

-0.30

1.20

74.00

72.00

72.00

0.30

72.30

OTM

2.00

-0.30

1.70

74.50

72.00

72.00

0.30

72.30

OTM

2.50

-0.30

2.20

75.00

72.00

72.00

0.30

72.30

OTM

3.00

-0.30

2.70

75.50

72.00

72.00

0.30

72.30

OTM

3.50

-0.30

3.20

76.00

72.00

72.00

0.30

72.30

OTM

4.00

-0.30

3.70

76.50

72.00

72.00

0.30

72.30

OTM

4.50

-0.30

4.20

77.00

72.00

72.00

0.30

72.30

OTM

5.00

-0.30

4.70

In the above case, the break even for the synthetic call will be Rs.72.30 because at that cost your cost of the future and the cost of the put option of Rs.0.30 will add up to create your break even. Above this level, your profits are unlimited and irrespective of how much lower you go your maximum loss will be limited top Rs.0.30 only. Here are a few key inferences that you can draw from this above table.

· The breakeven point is arrived at by adding the cost of the put option to the cost of the future. Above this point we can be profitable and the profits are unlimited above 72.30.

· This strategy is a good strategy to help you make money on the strengthening of the dollar or the weakening of the rupee. However, your downside risk is also covered in this case.

The question is what would have happened had we purchased a 71 strike put option instead of a 72 strike put option. What will be the trade off in this case? Let us check it out.

Buy Futures

72.00

Prem

N.A

Strategy

Synthetic Call or Protective Put Option

Buy ATM Put

71 Strike

Prem

0.05

Buy 72 futures and 71 put

Break Even

Once option cost is covered over the cost of Futures

Price

Buy Futures

Put Strike

Put Premium

Break Even Cost

ITM / OTM

P/L on Futures

P/L On Put

Sell Put P/L

68.00

72.00

71.00

0.05

72.05

ITM

-4.00

2.95

-1.05

68.50

72.00

71.00

0.05

72.05

ITM

-3.50

2.45

-1.05

69.00

72.00

71.00

0.05

72.05

ITM

-3.00

1.95

-1.05

69.50

72.00

71.00

0.05

72.05

ITM

-2.50

1.45

-1.05

70.00

72.00

71.00

0.05

72.05

ITM

-2.00

0.95

-1.05

70.50

72.00

71.00

0.05

72.05

ITM

-1.50

0.45

-1.05

71.00

72.00

71.00

0.05

72.05

ITM

-1.00

-0.05

-1.05

71.50

72.00

71.00

0.05

72.05

ITM

-0.50

-0.05

-0.55

72.00

72.00

71.00

0.05

72.05

ATM

-

-0.05

-0.05

72.50

72.00

71.00

0.05

72.05

OTM

0.50

-0.05

0.45

73.00

72.00

71.00

0.05

72.05

OTM

1.00

-0.05

0.95

73.50

72.00

71.00

0.05

72.05

OTM

1.50

-0.05

1.45

74.00

72.00

71.00

0.05

72.05

OTM

2.00

-0.05

1.95

74.50

72.00

71.00

0.05

72.05

OTM

2.50

-0.05

2.45

75.00

72.00

71.00

0.05

72.05

OTM

3.00

-0.05

2.95

75.50

72.00

71.00

0.05

72.05

OTM

3.50

-0.05

3.45

76.00

72.00

71.00

0.05

72.05

OTM

4.00

-0.05

3.95

76.50

72.00

71.00

0.05

72.05

OTM

4.50

-0.05

4.45

77.00

72.00

71.00

0.05

72.05

OTM

5.00

-0.05

4.95

In the above case, the break even for the synthetic call will be Rs.72.05 because at that cost your cost of the future and the cost of the put option of Rs.0.05 will add up to create your break even. Above this level, your profits are unlimited and irrespective of how much lower you go your maximum loss will be limited top Rs.1.05 only. Here there is something confusing! In the previous illustration, our max loss was limited to the premium, then why is it higher here? That is because the strike price is Rs.1 below the futures price. So your maximum loss is (Rs.1 difference + 0.05 premium paid on option). Here are a few key inferences that you can draw from this above table.

· The breakeven point is arrived at by adding the cost of the put option to the cost of the future. Above this point we can be profitable and the profits are unlimited above 72.05. The strike price of the put does not in any way impact the break even; that is still calculated by adding the premium cost to the futures price.

· This strategy is a good strategy to help you make money on the strengthening of the dollar or the weakening of the rupee. However, your downside risk is slightly larger in this case but your upside profits is also benefited and is also covered in this case.

You need to choose the strike price for the put option 72 or 71 based on y our view of the USD Rupee and the volatility you see. Ultimately, it is a trade off.