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Options: A Good Option for Currency Hedging

In today’s volatile currency markets, more and more companies are using options rather than forwards to hedge financial risks. Here’s why—and how to think about structuring an option hedge program.

By Jim Shepard | Updated on September 22, 2015

In the four years leading up to mid-2014, the euro averaged approximately 1.33 U.S. dollars and didn’t fall below 1.21 on a closing basis even once. There were some peaks and valleys along the way, but the euro held up fairly well throughout that time period. Then, in the summer of 2014, the euro began dropping in value—or, said another way, the U.S. dollar (USD) strengthened considerably. From May 2014 to June 2015, the euro-USD exchange rate fell by a whopping 22 percent.

When currencies move by this much, corporate treasury departments and company hedge programs catch the full attention of senior management and shareholders. In the recent past, we’ve seen companies reporting unfavorable currency impacts to their earnings, revenues, and margins, and they’ve blamed these results on the “strong dollar.” What’s puzzling is that most companies communicate to investors that they’re hedged against unfavorable movements, or at a minimum they indicate that they have a view into future results given some forward-looking hedge rate.

This situation begs the question: If companies are hedged, why are their results suffering so much from the recent phenomenon of the strong dollar? I postulate that there are three main reasons:

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