US Election uncertainties – Some option strategies for USDINR
Updated on 27th October 2020
The latest betting odds predict a win for Biden (67%) as per the betting site Oddschecker. The betting trend shows Biden’s lead (67% of Biden to 35% of Trump) is close to the highest point since the very start of the contest. The opinion polls are also predicting a Biden win, currently at +7.8 advantage over Trump, as per the RealClearPolitics average. While the polls and betting markets seem to indicate a Biden win, the experience of 2016 shows that with Trump, nothing can be assumed until the final results are in. Interestingly, the current trend in polls seems to mirror the 2016 trends, and whether the actual election results also would mirror the 2016 one is the million-dollar question.
Initially, the market feared a Democrat win would lead to a burden of onerous regulations, higher taxes for the rich, high spending on health care, etc. which are bad for risk sentiment in markets. But after the first debate on 29th September, the market seems to be recalibrating its thoughts. Investors are probably hoping for a stimulus bonanza that can lift the economy, more than that can be expected from a Republican presidency. Recent stimulus discussions have the Democrats demanding a 2.4 trillion package versus 1.1 trillion proposed by the Republicans. Markets expect that a Biden win (along with Congress/Senate win for Democrats) would lead to a continual stimulus.
While the focus is on presidential elections, markets are also keen on the congressional/senate elections, since they are more critical for ensuring appropriate fiscal stimulus measures are executed by the president. Generally, it is expected that these elections would go to the same party which wins the presidency, but there could always be surprises.
Having said all this, it is important to remember that the market predictions and voting outcomes very rarely match. As the D-day gets closer, the uncertainty may be more and volatility can continue in markets until after the election on 3rd November 2020. While the quantum of a potential stimulus package is an important factor, the view on COVID lockdowns between Biden and Trump could never have been more divergent. With Democrats in power, more severe lockdowns might be expected resulting in a deeper hit to the economy. In all, the elections present a highly volatile period for markets and corporations.
High volatility is never good for a company when the potential impact and direction of the currency is uncertain. In such a situation, options strategy is the best solution if chosen wisely to hedge the exposures.
- Out of the money call: Hereby paying a low premium and insurance for accidental moves can be obtained. If the rupee appreciates, no obligation and you get the appreciation benefit.
- Low-cost option structure: A zero-cost option strategy where the protection is up to a certain level and the appreciation benefit can be taken up to a certain level. The levels can be made custom fit as per the risk and reward levels chosen and appetite to pay a premium.
Example – protection starts at the forwarding level and ends at 1 rupee from forwarding level and provides a chance to take part in appreciation till 50 paise lower than the current spot. The cost is zero. Here if the spot goes beyond the protection level, you get 1 rupee better than the market rate. If the spot goes below the benefit level, you have an obligation to buy at the benefit level.
- Plain vanilla Put: Hereby paying premium insurance against appreciation can be taken and enjoy all the benefits in case of rupee depreciates.
- Low-cost option structure: This is a very good strategy when there is a decent possibility of rupee depreciation. If forward is taken and the rupee depreciates beyond the forwarding rate, you will be stuck at the forwarding level. But if this strategy is taken you can enjoy the depreciation benefit up to a certain level beyond the forward rate with protection at a lower level in case the rupee appreciates. Strikes can be modified according to the need.
Example – You can take protection at 50 paise below the current spot and enjoy the depreciation benefit till 90 paise better than the forward level. In between these two levels, you are at the market and above the benefit level, you have an obligation to sell at the benefit level.
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