Credit Agricole: currency managers should use dynamic overlay for hedges
Currency managers should consider using option strategies to offset the impact of volatile markets on FX hedges, according to analysts at Credit Agricole.
So-called solvency hedging using low cost out-of-the-money options can be used to protect hedges against large moves on underlying trades.
“We are seeing some of the most volatile moves in FX for 10 or 20 years and it makes sense to protect against tail events,” said Alexandra Ilinskaia, Head of FX Structuring and Quantitative Research at Credit Agricole CIB, at a conference in London. “The best way to do that is to use a dynamic strategy rather than a plain vanilla hedge.”
By using an active trading programme in FX derivatives, employing instruments such as barrier options, investors can protect themselves against large cash calls for rolling hedges or collateral, Ilinskaia said.
“If an FX forward or swap goes against you, an active currency overlay can significantly reduce the amount of cash required in times of liquidity crisis,” she added.
A UK based asset manager investing in USD assets and hedging with GBPUSD forwards would have faced significant cash calls to maintain their hedge three times in the past 10 years, according to Credit Agricole data, in 2005, 2008 and February 2010.