One of the surprising results when calculating the hedging costs of a basket of ETFs tracking foreign currencies was the relatively high hedging cost of the CurrencyShares Aussie Dollar Trust ETF (FXA). Not only was it the most expensive of these currency ETFs to hedge, it was also more than twice as expensive to hedge as the CurrencyShares Euro Trust (FXE). Given the continuing crisis in the eurozone, I found that interesting. Another interesting result to me was that the ETF tracking the Japanese Yen, CurrencyShares Japan (FXY), was the least expensive to hedge, despite Japan's huge debt as a percentage of GDP.
The table below shows the costs, as of Tuesday's close, of hedging FXA, FXE, FXY and three other foreign currency ETFs against greater-than-15% declines over the next several months.
For comparison purposes, I've also added the cost of hedging the PowerShares U.S. Dollar Index ETF (UUP) against the same decline. First, a reminder about what optimal puts are, and a note about decline thresholds, then, a screen capture showing the optimal puts to hedge one of the currency ETFs listed below, CurrencyShares Japan (FXY).
About Optimal Puts
Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones.
In this context, "threshold" is the maximum decline you are willing to risk in the value of your position. You can enter any percentage you like for a decline threshold when scanning for optimal puts (the higher the percentage though, the greater the chance you will find optimal puts for your position). I usually use 20% thresholds when hedging equity ETFs, but I've used 15% thresholds for these currency ETFs because they're less expensive to hedge and currency ETFs can be somewhat less volatile.
The Optimal Puts For FXY
Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of FXY against a greater-than-15% drop between now and June 15, 2012. One note about these optimal put options and their cost: to be conservative, Portfolio Armor calculated the cost based on the ask price of the optimal puts. In practice an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask.
Hedging Costs As Of Tuesday's Close
The hedging data in the table below is as of Tuesday's close, and is presented as a percentage of position value.
|FXA||CurrencyShares Aussie Dollar||3.55%**|
|FXE||CurrencyShares Euro Trust||1.64%**|
|CYB||WisdomTree Dreyfus Yuan||0.58%*|
|FXB||CurrencyShares British Pound||0.96%**|
|FXF||CurrencyShares Swiss Franc||3.61%**|
|UUP||PowerShares US Dollar Index||1.04%**|
*Based on optimal puts expiring in April, 2012
**Based on optimal puts expiring in June, 2012
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.