Foreign exchange derivatives houses including Bear Stearns, BNP Paribas and HSBC are recommending European corporates with dollar exposure hedge against further depreciation of the greenback. Euro/dollar will reach USD1.22 by year end, according to Hans Redeker, global head of fx strategy at BNP in London, noting that implied volatility is still low and is set to rise.
Redeker said corporates should now take advantage of this low volatility and use plain vanilla strategies, such as buying a euro call to capture the rise in the euro as well as taking a long volatility position. He added that corporates should not be selling volatility in this environment as it would be dangerous to write risk in a market that is trending from orderly to disorderly. But as implied volatility rises, the firm will recommend more exotic trades for clients to keep premiums down.
In an example trade, structured by Bear Stearns, a company buys a USD120 euro call/dollar put with a knock out at USD130.25 and sells a USD113 euro put/dollar call with a knock out at USD130.25. This was priced on Friday at a spot of USD117.50 and works out as a zero-cost option because the knock out reduces the cost of buying the euro call and allows the euro put strike to be pushed lower than in a typical risk reversal trade. Gilles Bransbourg, head of European foreign exchange sales at Bear Stearns in London, explained that the firm believes the current account deficit in the U.S. will push euro/dollar levels into the USD120-125 range within the next few months. Pegging a knock out at USD130.25 avoids the structure being cancelled at a symbolic barrier at USD130, he noted.
HSBC is predicting euro/dollar will reach USD127 by the year end, said Martyn Brush, managing director in foreign exchange derivatives at HSBC. He said the firm has been in ongoing discussions with corporate clients about how to prepare for this. "We have been calling for this move for a long time," he said, but that "you can't force clients to trade."
