An FX Options guide to get you through currency volatility during the US election
Disclaimer: This document is for information purposes only and is not in any way offering advice, nor should it be used to offer advice.
Historically, presidential elections have been pivotal in major market moves and we are expecting much of the same this year, including the chaos surrounding COVID-19 and its impact on the running of the elections.
Key Details for the 2020 Election
When is the US 2020 election?
3 November is the official date of the US election.
Who are the candidates?
The Republicans are the conservative political party in the US, President Donald Trump is the candidate for this party, looking to secure another four years in power.
The Democrats are the liberal party in the US, Joe Biden is the candidate here, who is well-known for serving as Barack Obama’s vice president.
When do we know the results?
It can take several days for each vote to be counted, but usually early hours of the next morning (4thNovember), will give the market a clear indication.
The US Elections Impact on Foreign Exchange
Over the course of an election cycle, issues such as international trade, national security, and government spending become focal points of the national discussion. As a result, the financial markets tend to fluctuate and currency volatility is expected before, on and after election day.
The result of the U.S. general election exerts much influence on the institutions of the world, and it’s a major factor in global political and economic landscapes.
What can we expect from a Joe Biden win?
The possibility of a Biden win could lead to a weak US dollar in the long-term, according to market analysis. His agenda focuses on tax hikes, reducing consumer spending and opening the US to more international trade with Europe and the Far East as a result of reductions in tariffs. A new leader in most cases does cause uncertainty in the currency of an economy.
What can we expect from a Donald Trump win?
Retaining the presidency means more of the same from Trump. Market analysis indicates the likelihood of a strong US dollar should Trump take home victory. His aggressive approach with China and Europe on trade relations is likely to continue. Further tax cut proposals in a bid to support public spending and productivity to “Make America Great Again” seems to be the slogan he will stand by.
Mitigating the Risk of Currency Volatility
Options can be highly useful in a volatile market that could go either way, political events such as the US elections are a prime example of this. Where a forward contract offers you 100% protection but no possibility of upside/partaking in movements in your favour, an FX Option allows an opportunity for both.
What is an FX Option
A Vanilla Option is a foreign exchange contract between two parties that gives the holder, or purchaser, of the option the right, but not the obligation, to exchange one currency for another currency, for a specified amount, at a specified exchange rate (known as the strike rate) at a specified date in the future. To purchase this option the buyer pays the seller an upfront premium.
A Vanilla Put Option gives the holder the right to sell the base amount of currency, under the terms specified above.
Advantages
- Provides full protection from adverse currency movements in the EURUSD exchange rate.
- Ability to benefit fully from any appreciation of the EURUSD exchange rate.
- Ability to customize the strike rate to a level that suits your needs.
Disadvantages
- Premium must be paid upfront
What Happens at the Point Expiry
At the expiry date there are two possible scenarios:
If the spot rate at expiry is less favourable than the strike rate client has the right, but not the obligation, to trade the notional amount at the strike rate.
If the spot rate at expiry is more favourable than the strike rate client has no obligation and is free to trade at the market rate.
An Example of a Vanilla Option
John needs to make payments form EUR to USD for stock purchases within in the next 3 months
selling
1,000,000.00 EUR
Spot Rate
1.1850
Buying
USD
Risk Profile
As John is selling EUR and buying USD, his risk is in the EURUSD rate falling from the current spot price of 1.1850, therefore making the products more expensive.
Expiry Date
29 Jan 2021 (3 Months)
Selling
1,000,000.00 EUR
Strike Rate
1.1850
Buying
1,185,000.00 USD
Premium Payable
for further details why not get in touch
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