Currency Hedging your Aussie Dollar in the US - Andrew Baxter

 

Trading US stocks from Australia has never been easier. The development of online trading platforms, faster internet access, and electronic transactions means you can be set-up within a week, and buying some of the most well known companies from the largest stock exchange in the world.

Investors need to be aware of the risk of a fluctuating currency when trading US stocks from Australia. Once you have funded your account with Australian Dollars, purchasing shares from a US exchange will either be on margin with a RegT account, or will require US dollars for a Cash account.

Cash Accounts

For Cash accounts, you can transfer funds into USD as you need to purchase shares. Or, you can transfer a lump sum across (which will reduce fees), and have your capital sitting in US dollars in preparation of entering stock positions.

If the Australian dollar rises while you have US dollar exposure, the value of your cash/stock in Australian dollar conversion will decrease. This is irrespective of whether you are making a gain or loss in your stock positions. Basically, it will reduce any gains you are making, and accentuate any losses you have made. For this reason, it is a good idea to Hedge your Currency exposure when you transfer your AUD into USD so that you negate the fluctuation of the AUD/USD currency.

Of course, if the AUD declines against the USD, the value of your cash/stock will increase. But if you start ‘picking’ when to hedge and when not to hedge, you add additional risk of getting it wrong. Hence, the lower Risk approach is to hedge your USD exposure as soon as you transfer funds.

So for example, if the AUD were to rise from $0.90 to $0.925, this would be an approximate 2.8% decrease in the value of your US investments (cash and stock value). In essence, that would negate nearly a month’s worth of Covered Call trading. Hence, there is an importance for hedging currency exposure.

How much you need to hedge

To equate how much you need to hedge, there is a quick and easy method of identification if using the Halifax TWS platform. In your Trader Work Station (TWS) Account review tab, identify the Market Value – Real FX Balance section. You may need to expand this section with the green plus at the right hand side of the screen. Under Currency, find the USD line. And scroll across to the Net Liquidation Value column. It is this value that you need to use in your calculation.

Account Exposure

In the above example, this account has $46,791 USD exposure. The Risk is that the Aussie Dollar rises against the USD.

To hedge our USD, for a RegT account we establish an FX Margin position to an approximately equal value. While for a Cash account, it cannot use FX Margin and so we use an alternative strategy with an Exchange Traded Fund (ETF) – FXA.

The following defines how you do this for either a RegT or Cash account.

RegT Accounts

To place a currency hedge position with a RegT account, load the AUD.USD onto a quote page. As per the image below, you need to select IDEALPRO. The position is to Buy the AUD.USD, with the Quantity as close to your Net Liquidation value, as defined earlier. You can place this at a limit, or you can place this at Market, depending on your preference.

TWS quote page

Your order confirmation screen will appear as below:

Halifax TWS Order Confirmation

In this example, the Initial Margin to hold this position is $1,221 to place a Currency Hedge position worth $50,000. As the AUD rises, the value of this position will rise. As the AUD falls, the value of this position will fall. This will offset the fluctuation in the Net Liquidation value of your USD exposure.

Cash Accounts

To place a Currency Hedge position for a Cash account, we cannot use FX Margin. The alternative is to gain exposure to the Australian dollar through a listed Exchange Traded Fund (ETF). For AUD, it is FXA – CurrencyShares Australian Dollar Trust, which is listed on the New York Stock Exchange (NYSE).

Our set-up to place a position is first to choose which option position we will be purchasing for FXA. We need to select a strike and a time till expiry. Our guidelines in this selection process are:

1. Buy enough time to be right. This is typically a minimum of 6-months for this Currency Hedge
2. Select a deep ITM strike that has a high Delta. Reason being that this will reflect the change in the AUD.USD as closely as possible.

As the following chart depicts for the AUD.USD as at 23rd May 2014, the long-term low is at 0.865; the medium-term high is around 0.975 and the long-term high is around 105.5. The December option contracts are 7-months from expiration, and the 86.00 strike is below the long-term low and has a Delta value of 0.83 (at time of writing).

Therefore, the Dec 86.00 Call, which last traded at $6.50 per share, will move $0.83 for every dollar the AUD.USD moves. Should the AUD rise, the delta will increase and the position will move closer to 1 for 1. If the AUD falls, the Dec 86.00 calls will be worth very little below $86.00.

AUD/USD Chart

To hedge the $50,000 exposure from the previous example, we would consider purchasing 5 contracts, which will require $3,250. If the AUD falls, this position will have some value through to 0.86AUD, however, the value of the cash/stock in USD increases accordingly as well. A rise of the AUD will see the FXA call option increasing in value, offsetting the decrease in Net Liq value of the USD exposure.

Purpose of the Currency Hedge

Purpose of the Currency Hedge is to offset a rise in the AUD.USD as our capital/stock value will decrease. For this reason, the investor is better suited to always have a hedge position in place. Because there is Time Decay in the FXA Call option used to hedge the currency, this position needs to be managed.

Our view is to Roll the position when there is plenty of time still available. For example, if we are using the December expiry, we would adjust the position in October, rolling out to the April, May or June options of the following year. Irrespective of gain or loss in the original option position (because a gain in the option means a loss in the value of stock/cash, and vice versa).

Maintain a high Delta

At the same time, we are regularly evaluating the Delta of the call option position. Our goal is to maintain a high Delta. If the AUD.USD rises, we will evaluate rolling the strike higher to an equivalent Delta from entry. If the AUD.USD falls, we will typically maintain the position as we have no need to hedge the currency fall. However, once the AUD.USD ends its downtrend, we need to realign our position with a higher Delta call option. Otherwise, we will not recover the same value amount. Hence, we are still adjusting the Call option position as AUD.USD falls to ensure we have a high Delta position.

The only time we remove the FXA Call option from our portfolio is when we are transferring USD back into AUD, as the position is no longer required.

If you have any questions about this article please leave a comment below, alternatively you can book in for a one-on-one consult by contacting us