Using Options to Hedge Eurodollars Through Non-farm Payrolls

A fortunate coincidence exists in the currency futures options on the Chicago Mercantile Exchange (CME) in that the monthly serial options normally expire on the day of payroll. This presents an ideal opportunity to hedge or speculate through the number with relatively low risk. Occasionally there is the added bonus that it also coincides with the European Central Bank’s (ECB) interest rate decision and ECB president Jean-Claude Trichet’s press conference the day before. This was the situation last week.

If you purely wish to speculate, the normal strategy is to simply purchase a straddle (a call and a put) one strike away from the current price. If you need to hedge, there is normally a bias and risk against the current trend. Eurodollars broke up some time ago and the market had major resistance at 1.5136, which was just 200 points above the price coming into last week’s press conference. This means that the profit in purchasing a call (buying the right to buy) is relatively low.

Therefore a hedging strategy involves purchasing puts (buying the right to sell). On Thursday morning, the eurodollar was trading at 1.4900. In order to give the best protection at the lowest cost it is necessary to buy one strike out of the money puts. These were the 1.4850’s. Figure 1 shows an overlay of that option and the spot price. The option could be purchased for 85 points and, with both volatility and a potential trend move possible through such important statements, the premium is low in relationship to risk. To give some perspective, a three-month put cost 485 points. If the market’s reaction is bullish, only a small price (the premium of 85 points) has been paid. As it transpired, Trichet’s speech shocked the market as he considerably toned down his previous hawkish rhetoric. The fact that the ECB has a reputation for being obsessed with inflation and that oil and silver surged since the last meeting added to the surprise.

With the unexpected news, prices had to adjust and a major slide occurred. With payrolls also being strong, the trend has made a decisive change. Those that needed to hedge now have a short futures position at 1.4765 (the difference between the strike 1.4950 and the premium 85), while speculators at nearly 400 points in the money can book at least partial profits.

Figure 1: The Eurodollar Falling Makes the Put Price Rise

Source: CQG



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Mark Carney Bank of England