So I want to expand my trend following universe, with my USD base currency account. I'm looking at futures denominated in Euro, GBP, and maybe some Asian futures (AUD, Singapore, Malaysia). My question is - what do we have to hedge for the forex risk. Is it: a) The daily mark to market difference; and b) The margin - would IB charge the margin in Euros via a negative debit the same way they do with foreign stocks, or do they convert and charge it in USD? c) Assuming I don't have to hedge the whole notional value, as I'm only betting on a price difference not on the whole thing? Anything I missed? Really just want to know how to calculate how much to hedge..
Focus on the important parts hey Let's say "AUD AND Asian" is what I meant, if I can make Tony happy it's a successful day.
You can trade the quanto future for Nikkei 225. The symbol is NKD (US dollar denominated). Generally speaking, you trade futures to hedge the risk. It won't really matter unless you take long term trades on Asian indices/stocks. Use the notional value of the contract (see contract specs) and equate it to your fx holdings. I have transferred USD to JPY and traded futures on the Osaka Derivatives Exchange and, at the time, I was subscribed to the TSE indexes and had all the quotes. Interestingly, they also have mini and micro size instruments. The broker would even let me spread them against the US suite of futures. SGX also has Nikkei products available.
You don't have to hedge anything. I just make sure I have enough of each currency to cover the margin so that I'm not paying margin interest and occasionally convert excesses back to your base currency if needed. Yes, you'll have some fluctuations in you P&L due to moves in fx rates, but it will be small compared the trading P&L (for me, less than 1% in each of the last two years).
This is just me...I OWN FXA FXE FXC. They may have other currencies. I could do options on these if I wished...FXC I did. The other two, I only have 50 shares each. They also pays a small dividend...About 1-2%. Just a way to play currencies, but there are higher management fees involved...
Why use the notional value to hedge? As an example, say we have the Euribor contract, denominated in euros with a USD account. Due to low volatility, sizing of STIR positions would be maybe 5x account size. So we have a $100k USD account, and a $500k (USD converted from euro) position in Euribor. On this date in the backtest it was held for 63 bars and the profit was $1750 after converting from euros to USD. During that time the exchange rate changed by 7.4%, if we had hedged the notional $500k worth of euro we would have lost $37k on the hedge which is 37% of the account! Wouldn't it make sense to only hedge the P&L and not the notional? If you have a hedge that large, you'd even need a stop on it because the risk is higher than the actual position. For euro stocks it's different, you hand over euro cash to buy them, and when you sell you get back the full notional in euros. So for stocks I think you would be correct. But for futures, I don't see the argument to hedge the full notional. It does make the brain spin at first to think about it though! The reason I think this is a good discussion, is because information out there is so conflicted on this.
I probably put the wrong title, but I'm most interested in how to calculate trade results from foreign contracts. Some told me that the full notional value of the underlying instrument is exposed to currency fluctuations. But I'm pretty sure that's wrong, because with Futures no money changes hands at open or close. Only the daily mark to market price difference changes hands. Thanks! That's good to hear real experience with that, as I've only ever chosen USD based contracts so far. I have some work to do to make my backtesting compatible, but I think it will be worth it for the extra diversification.