Buying FEX Call Option as Euro risk insurance

[BlueBuddha]

We recently placed a build order for a new Lagoon 42. Because we are dealing directly with a European broker company, the price is in Euros. The down payment in USD was calculated using the Euro rate this past Friday, but the final price will be calculated at closing sometime in August at whatever the rate is at the time.

As you can imagine, that scares me. So I'm considering options (no pun intended). One solution is to simply start buying Euros or an Euro ETF such as FXE. If the Euro takes off, so will the ETF and we would be covered. If the Euro crashes, the ETF will crash too, but our money requirement will also be lower.

Another alternative is to purchase a Jan 18, 2019 call option to buy FEX at today's value. It will cost about 3% of our boat cost but it will cap any currency risk to today's rate. If the rate increases significantly, we can exercise the option, then sell the ETF stocks and collect the right amount of money. If the rate crashes, we can let the option expire, loose the 3%, but get it back in the form of a lower US boat cost if the rate drops by more than 3% or so.

So I think buying a call option for FEX at today's value is a cheap insurance to lock today's euro rate and hedge against currency risks.

Am I missing something?

[TJ D]

Originally Posted by BlueBuddha

We recently placed a build order for a new Lagoon 42. Because we are dealing directly with a European broker company, the price is in Euros. The down payment in USD was calculated using the Euro rate this past Friday, but the final price will be calculated at closing sometime in August at whatever the rate is at the time.

As you can imagine, that scares me. So I'm considering options (no pun intended). One solution is to simply start buying Euros or an Euro ETF such as FXE. If the Euro takes off, so will the ETF and we would be covered. If the Euro crashes, the ETF will crash too, but our money requirement will also be lower.

Another alternative is to purchase a Jan 18, 2019 call option to buy FEX at today's value. It will cost about 3% of our boat cost but it will cap any currency risk to today's rate. If the rate increases significantly, we can exercise the option, then sell the ETF stocks and collect the right amount of money. If the rate crashes, we can let the option expire, loose the 3%, but get it back in the form of a lower US boat cost if the rate drops by more than 3% or so.

So I think buying a call option for FEX at today's value is a cheap insurance to lock today's euro rate and hedge against currency risks.

Am I missing something?

I think that you might be making it more complicated than it needs to be. If you have confidence that today's rate is advantageous to you, why not transfer the entire sum now? I would be surprised if there wasn't a way to put the funds for the boat into escrow over in Europe. Ask the broker over there. I would prefer to do that before dabbling in FX products if I could.

[BlueBuddha]

Originally Posted by TJ D

I think that you might be making it more complicated than it needs to be. If you have confidence that today's rate is advantageous to you, why not transfer the entire sum now? I would be surprised if there wasn't a way to put the funds for the boat into escrow over in Europe. Ask the broker over there. I would prefer to do that before dabbling in FX products if I could.

Yes, this is the most straightforward path, but purchasing the call option provides protection on both sides of the risk. If I buy euros (or simply buy the Euro ETF) and the euro crashes, I lose the opportunity to benefit from the advantageous exchange rate as my $ will also crash. With the call option, if the euro crashes more than 3% I can let it expire and buy the euros at the market rate.

It is definitely a costly insurance and I am more worried about a potential run of the Euro than about the risk of missing a favorable crash. So I am still considering buying the call option as insurance vs. simply buying the euros. Thanks.

[Cavalier]

Originally Posted by BlueBuddha

Yes, this is the most straightforward path, but purchasing the call option provides protection on both sides of the risk. If I buy euros (or simply buy the Euro ETF) and the euro crashes, I lose the opportunity to benefit from the advantageous exchange rate as my $ will also crash. With the call option, if the euro crashes more than 3% I can let it expire and buy the euros at the market rate.



It is definitely a costly insurance and I am more worried about a potential run of the Euro than about the risk of missing a favorable crash. So I am still considering buying the call option as insurance vs. simply buying the euros. Thanks.

The variance in USD->EUR hasn't been much greater than 5% since mid-2014. A 3% cost seems to be a high price for the net 2% upside. On that basis, I'd just transfer the money into escrow. Unless, of course, you know something about the future FX market the market doesn't...

[BlueBuddha]

Originally Posted by Cavalier

The variance in USD->EUR hasn't been much greater than 5% since mid-2014. A 3% cost seems to be a high price for the net 2% upside. On that basis, I'd just transfer the money into escrow. Unless, of course, you know something about the future FX market the market doesn't...

Definitely, I do not have a crystal ball but I'd say most agree the geopolitical situation in the US is a bit different than it was during the last few years. And then there is North Korea (I want a boat to outrun the nukes ).

Anyhow, the Euro is up 12% YTD. Overall the average change may be closer to 5%, but there is definitely a risk of 10+ point changes in 9 months. But yes, the 3% is an expensive insurance.

[TJ D]

Originally Posted by BlueBuddha

Definitely, I do not have a crystal ball but I'd say most agree the geopolitical situation in the US is a bit different than it was during the last few years. And then there is North Korea (I want a boat to outrun the nukes ).

Anyhow, the Euro is up 12% YTD. Overall the average change may be closer to 5%, but there is definitely a risk of 10+ point changes in 9 months. But yes, the 3% is an expensive insurance.

I suppose my point, in brief, was that if you're comfortable with your USD outlay with the exchange rate where it is, why not go ahead and go into a Euro-based escrow account and be done with it? It sounds like you're confident that there's more downside to USD, so this seems simple and sensible to me.

[did-g]

Originally Posted by BlueBuddha

We recently placed a build order for a new Lagoon 42.

So I think buying a call option for FEX at today's value is a cheap insurance to lock today's euro rate and hedge against currency risks.

Am I missing something?

Double checking IRS implication? It could make this stuff more interesting or less...

[BandB]

I wouldn't put it in an escrow account, but I would buy the contracted Euro price worth of Euro's today or at least 90% of it. It was always my business philosophy that I wasn't in the exchange game, so anytime we entered into a contract in another currency, we bought enough of the other currency to cover the price. That's what you showed as your first alternative. I would not get into options or make it any more complicated than it must be.

And for those who say it never varies over 5%, it doesn't in the long run but it's taken some pretty big swings at different times from 5% below the base to 5% above or even greater before returning to normal. The risk is that Murphy is involved and you have to pay at absolutely the worst time.

Now, while my philosophy is as stated above, in late 2015, I ordered a UK built boat. Stupid I know but the rate went from 1.56 when I placed the order to 1.39 when I took delivery. The boat cost $340,000 less than the price at the time I ordered it. Sounds like I saved a bunch of money and, in the short term I did. However, ultimately my boat is worth less as a result of that drop if I was to try to sell it. The rate dropped further and only now has leveled at 1.35. What it means in the long run, I have no idea. I know right now on the used market 2015, 2016, and 2017 models have virtually identical sales prices in US $, less than 15% under what I paid. I think I only benefit though if the pound sterling takes off back up, raising the price for new boats again.

Regardless I would protect myself if I was you. In the first 8 months of this year the Euro went from 1.05 to 1.20. That kind of rise would have added almost 15% to your purchase price. What if it returned to 1.39 where it was in April, 2014? Don't gamble. Protect yourself.

[svlamorocha]

Originally Posted by BlueBuddha

We recently placed a build order for a new Lagoon 42. Because we are dealing directly with a European broker company, the price is in Euros. The down payment in USD was calculated using the Euro rate this past Friday, but the final price will be calculated at closing sometime in August at whatever the rate is at the time.
As you can imagine, that scares me. So I'm considering options (no pun intended). One solution is to simply start buying Euros or an Euro ETF such as FXE. If the Euro takes off, so will the ETF and we would be covered. If the Euro crashes, the ETF will crash too, but our money requirement will also be lower.
Another alternative is to purchase a Jan 18, 2019 call option to buy FEX at today's value. It will cost about 3% of our boat cost but it will cap any currency risk to today's rate. If the rate increases significantly, we can exercise the option, then sell the ETF stocks and collect the right amount of money. If the rate crashes, we can let the option expire, loose the 3%, but get it back in the form of a lower US boat cost if the rate drops by more than 3% or so.
So I think buying a call option for FEX at today's value is a cheap insurance to lock today's euro rate and hedge against currency risks.
Am I missing something?

Two problems with the option:

a) The exchange-traded option maturities available today do not include the date you want; they fall short by seven months. Brokers will tell you that you can "roll over" the position but you are left with basis risk at rollover.

b) You are still left with a payout in US dollars and if you are not careful your bank will fleece you by 3% or so when converting USD to EUR at the time of closing. Therefore it is not just about variation in the EURUSD pair, it is also about the margin they charge on the spot EUR/USD trade.

If I was you (and assuming you are a US citizen or live in the US) I would either:

a) open a EUR bank account with Citibank UK and fund it with EUR purchased at low spread through a currency broker such as Oanda (pay flat fee and get wholesale rates) or

b) buy a US-market ETF that invests in EUR-denominated short term securities (FXE?) inside a Schwab brokerage account and when the time sell the ETF and get Schwab to sell you the EUR (best rate of all US retail stockbrokers) in the form of a EUR wire to Lagoon or the dealer.

First option may be complex if you have not dealt with a proper currency broker that exchanges money in your US$ account for money in your EUR account right now (do not confused with "FX" scammers that pray on wannabe speculators), but it is easier to avoid risk of income tax.

Second option is easier but you way end up paying US income tax on a gain without deduction for the offsetting loss (unless your accountant knows how to claim "hedge accounting" in a personal return)

Dont even think of sending a USD wire to the dealer or Lagoon because they are going to fleece you unless you have a good alternative ready to fire.

PS: Years ago I made a living looking at holes in supposed hedging strategies peddled by brokers. I have lived in many counties and hate to be fleeced by financial institutions.

[BlueBuddha]

Originally Posted by BandB

Regardless I would protect myself if I was you. In the first 8 months of this year the Euro went from 1.05 to 1.20. That kind of rise would have added almost 15% to your purchase price. What if it returned to 1.39 where it was in April, 2014? Don't gamble. Protect yourself.

Ahhh, thanks for the cortisol shot! That is one scary thought

[BlueBuddha]

Originally Posted by svlamorocha

Two problems with the option:

a) The exchange-traded option maturities available today do not include the date you want; they fall short by seven months. Brokers will tell you that you can "roll over" the position but you are left with basis risk at rollover.

b) You are still left with a payout in US dollars and if you are not careful your bank will fleece you by 3% or so when converting USD to EUR at the time of closing. Therefore it is not just about variation in the EURUSD pair, it is also about the margin they charge on the spot EUR/USD trade.

If I was you (and assuming you are a US citizen or live in the US) I would either:

a) open a EUR bank account with Citibank UK and fund it with EUR purchased at low spread through a currency broker such as Oanda (pay flat fee and get wholesale rates) or

b) buy a US-market ETF that invests in EUR-denominated short term securities (FXE?) inside a Schwab brokerage account and when the time sell the ETF and get Schwab to sell you the EUR (best rate of all US retail stockbrokers) in the form of a EUR wire to Lagoon or the dealer.

First option may be complex if you have not dealt with a proper currency broker that exchanges money in your US$ account for money in your EUR account right now (do not confused with "FX" scammers that pray on wannabe speculators), but it is easier to avoid risk of income tax.

Second option is easier but you way end up paying US income tax on a gain without deduction for the offsetting loss (unless your accountant knows how to claim "hedge accounting" in a personal return)

Dont even think of sending a USD wire to the dealer or Lagoon because they are going to fleece you unless you have a good alternative ready to fire.

PS: Years ago I made a living looking at holes in supposed hedging strategies peddled by brokers. I have lived in many counties and hate to be fleeced by financial institutions.

Thank you so much. This is very useful.

I was considering a call option for FXE for Jan 2019. It is expensive so far out but I would be able to exercise it all the way till the day of closing.

Just buying FXE on my Charles Schwab account was my initial thought and I may still do that given that the likelihood of a drop of the euro is pretty unlikely. I did not consider the income tax ramification, which reduces the value of the FXE protection to some degree.

Thank again.

[Drew13440]

I would look at futures contracts and/or options on those. Transaction costs will be lower and spreads tighter. They are also a pure currency play in a way that ETFs are not, being based upon a hodge podge of underlying, related assets.


At this juncture in time, IMO, going the ETF route also exposes one to broader market risk. It is unwise, again IMO, to expect these vehicles to behave as designed in the event of major market turmoil.


Whether the latter comes before closing on the boat, I've no idea, only that it is coming. Why take the risk? Go futures contracts or just buy Euro outright now.

[BlueBuddha]

Originally Posted by Drew13440

I would look at futures contracts and/or options on those. Transaction costs will be lower and spreads tighter. They are also a pure currency play in a way that ETFs are not, being based upon a hodge podge of underlying, related assets.
.

Good idea. I am not familiar with currency future/contracts so the idea of simply buying a call option for FXE seemed simple as I am quite familiar with call options (although most often I'm selling covered calls).

I will do some research on FX futures and examine the costs. Thanks

[Dtm67]

One other option is Interactive Brokers. They are one of the few US based brokerages I have found that will allow for euro denominated holdings for an American like me. And at pretty low cost too if you meet their minimums.

I also have a euro hedge for similar reasons to you. I elected to buy euros on the open market and also hold euro denominated low volatility stocks that allow me to participate in the market in the meantime.

When the time comes to close the deal on the boat, its a matter of cashing out the investments and wiring the euro denominated funds.

There is a balance to be struck between how much to hold in actual euros (with no market risk) and how much to invest in a diversified euro denominated portfolio. That's a question of risk tolerance. But at least the currency risk is gone. One drawback to this strategy is the euro cash holding gets no interest payment (dollars pay interest, although somewhat paltry)

Anyways, that's my two cents. I'm also curious what others have done beyond what's been shared so far. Or feedback on my strategy...

[captmikem]

I think a straddle would be your best option, (pun intended) if nothing moves you lose a bit, but if it moves your slight loss on the loser should more than compensated by your gain.

M