What Ken wants to achieve

Ken does not want to eliminate all currency risk. He accepts that part of investing internationally is living with exchange rate movements. However, he would like to:

• Define a worst-case level for EUR/CHF over the coming months for part of his euro assets.
• Avoid the need to monitor and adjust spot hedges every time EUR/CHF moves by a small amount.
• Keep some flexibility to benefit if the euro strengthens.

These objectives lead him to consider FX options as a complementary tool alongside his existing portfolio.

Using a EUR/CHF put option as a protective hedge

Ken’s main concern is that EUR/CHF might fall sharply over the coming months. To address this, he looks at buying a EUR/CHF put option with an expiry in about six months, which he can later renew if his concern extends beyond that period.

At a high level:

• The underlying pair is EUR/CHF, consistent with his euro exposure against CHF.
• The strike price is chosen near a level that, if breached, would create discomfort for him in CHF terms.
• The expiry date is set to cover the period he is most concerned about, such as the next six months.

By buying this put option, Ken acquires the right, but not the obligation, to sell euros against Swiss francs at the strike price on or before the expiry date. If EUR/CHF falls below that strike, the value of the option can increase, helping to offset the decline in the CHF value of his euro assets. If EUR/CHF remains stable or rises, the option may expire worthless. In that case, the cost of the premium is the price Ken has paid for protection.

Scenario comparison looking at a Saxo strategy window

Important note: The strategies and examples provided in this article are purely for educational purposes. They are intended to assist in shaping your thought process and should not be replicated or implemented without careful consideration. Every investor or trader must conduct their own due diligence and take into account their unique financial situation, risk tolerance, and investment objectives before making any decisions. Remember, investing in the stock market carries risk, and it's crucial to make informed decisions.

On Saxo’s FX option strategies ticket, a protective hedge for part of Ken’s euro exposure can look like this:

In this illustration, Ken chooses to hedge 100,000 EUR of his euro-denominated assets. He buys an EUR/CHF put option with:

• Notional: 100,000 EUR (matching part of his euro exposure)
• Strike: 0.9200
• Premium paid: 974 CHF
• Maximum loss on the option at expiry: 974 CHF (the premium)
• Breakeven at expiry: 0.91026 (ignoring transaction costs and other pricing factors)

With spot around 0.9332, 100,000 EUR corresponds to roughly 93,300 CHF of underlying exposure. The option premium of 974 CHF is about 1% of that exposure. In effect, Ken is paying about 1% of the protected amount to lock in a worst-case exchange rate for the hedge period.

To see the impact, consider some simplified scenarios at expiry, using rounded numbers and assuming he keeps both his euro assets and the hedge until that date:

• EUR/CHF falls to 0.88
  • The CHF value of 100,000 EUR falls by about 5,300 CHF.
  • The put is worth roughly (0.9200 − 0.88) × 100,000 = 4,000 CHF. After subtracting the 974 CHF premium, the net benefit from the option is about 3,000 CHF.
  • Instead of a 5,300 CHF loss without a hedge, Ken’s net loss on this portion of his exposure is reduced to roughly 2,300 CHF.
• EUR/CHF stays near 0.93
  • The CHF value of his euro assets is broadly unchanged.
  • The put expires worthless and Ken has effectively paid 974 CHF for insurance he did not end up needing.
• EUR/CHF rises to 0.98
  • The CHF value of 100,000 EUR increases by about 4,700 CHF.
  • The put expires worthless, so Ken still keeps the extra 4,700 CHF, reduced by the 974 CHF premium, leaving a net gain of around 3,700 CHF.

These numbers are simplified and purely for educational purposes. They do not reflect current market conditions, and actual option prices will depend on volatility, time to expiry and other factors. The key point is that, by adding a long-dated EUR/CHF put, Ken limits the damage from a large euro decline while still participating in potential euro strength, reduced only by the cost of the hedge.

Adjusting the hedge to his needs

Ken does not need to hedge 100% of his euro exposure. Instead, he chooses a notional size for the EUR/CHF option that corresponds to the portion of his holdings he is most concerned about. He also understands that:

• A higher strike price generally provides stronger protection but comes with a higher premium.
• A lower strike price reduces the cost of the option but means that smaller moves in EUR/CHF are not hedged.

By adjusting the strike and notional size, Ken can tailor both the level of protection and the cost of the hedge to his own comfort level.

Considering more advanced structures

After some time using simple long put options, Ken learns that there are more advanced combinations that can reduce the upfront premium in exchange for limiting potential upside. One example is a collar structure, where he might:

• Buy a EUR/CHF put option to protect against a large decline
• Sell a EUR/CHF call option at a higher strike, which brings in premium but caps his participation in very strong euro appreciation

This approach is more complex and introduces additional obligations if the euro strengthens significantly. For that reason, Ken treats it as a later step, after he has become comfortable with how single long options behave.

Risks and practical considerations

As with any risk-management tool, FX options come with their own characteristics and considerations:

• Premium cost: the price of the option reduces Ken’s overall portfolio return if the adverse currency move does not occur.
• Time horizon: options have a fixed expiry. If his concern extends beyond that date, he needs to decide whether and how to renew the hedge.
• Complexity: more advanced strategies that involve selling options can expose him to potentially large obligations if the market moves strongly.

Ken finds it helpful to treat options as a structured way to pay for protection, rather than as a source of additional return.

What other investors can learn from Ken

Ken’s experience highlights several points that may be relevant for investors with foreign-currency assets or income:

• FX options can help define a worst-case exchange rate over a chosen period, making planning in the home currency easier.
• Simple protective structures, such as long puts on the relevant currency pair, can often be understood without needing to master every detail of options pricing.
• The cost of protection is an explicit trade-off against reduced uncertainty in the portfolio.

For investors who already hold diversified portfolios and are comfortable with the basics of FX, options on currency pairs can offer an additional way to align currency risk with their long-term objectives.