Icelandair plans to put on euro/dollar collars rather than purchase forwards to hedge its net short dollar position because, even though it believes the greenback is likely to weaken, it is required to hedge a minimum of 50% of its currency exposure. Sveinbjorn Indridason, director of treasury in Reykjavik, said the dollar might weaken because the airline sector and the U.S. stock markets are expected to sell off following terrorist attacks in Washington, D.C. and New York.
The Icelandic airline is committed to keep at least 50% of its foreign exchange exposure hedged rather than try to forecast future movements in the dollar. The airline plans to put on the fx collars if the dollar falls to USD0.95 against the euro. It would buy at-the-money euro puts and sell euro calls with strikes around USD0.97 to hedge its exposure. The euro was trading at USD0.91 on Monday. The USD0.95 level was built into the company's hedging strategy at the beginning of the year and existing hedges will be triggered at that exchange rate. The airline is a net buyer of approximately USD70 million dollars a year.
Indridason explained it wants to enter options rather than forwards but the increased uncertainty has made options more expensive. The company therefore opted for a collar strategy in which it would be both buying and selling volatility, making the trade less expensive. He envisages the trade will cost about 1% in vol because the options it is buying are at-the-money whereas the options it is selling are out-of-the-money. The likely notional size of the structure would be EUR1 million (USD910,000) per leg. He declined to name counterparties but said price and relationship are the most important factors.
