From the February 2012 issue of Treasury & Risk magazine

Weighing FX Options

As treasurers in Europe look to shield their companies from a possible breakup of the euro, the argument for using FX options becomes harder to ignore.

Treasurers are no strangers to currency volatility—the events of 2008, when volatility hit unprecedented highs, still feel very recent to most in the industry. But while volatility in the currency markets has generally subsided since then, the prospect of a euro breakup is keeping this topic uppermost in treasurers’ minds.

“Whilst we haven’t seen extreme moves in many markets—euro/dollar has been fairly volatile, but volatile within a range—the concern is what might happen going forward,” says Ross Niland, managing director at J.P. Morgan. “There is an increased focus from corporate treasurers as to where volatility may bring things, as opposed to how volatile the markets have been.”

In addition to the other benefits, Adam points out that options can give the buyer the opportunity to recoup value if the underlying market moves advantageously. “If you buy an FX option, you own an asset that entitles you to flexibility as well as protection,” he says. “Whilst it provides insurance, a favorable movement in the underlying market can offer the opportunity to lock in a better forward-market rate than you could have achieved when you bought the option. Locking in the forward also allows any residual value in the option to be realized.”

Often that’s the most difficult hurdle for corporations to clear, Adam says because “some companies will say that is speculating rather than hedging. A potential analogy is that most people who buy car insurance don’t tend to leave the car in the garage all year—that is not aiming to achieve optimal value for money. Many financial institutions are already over that hurdle and actively seek to deliver optimal value to their business through their hedging programs.”

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