Optimal Hedging Strategy for Euro Depreciation

Very Hard Derivative Strategies Hedging Strategies

As the Chief Investment Officer of an international portfolio management firm, you are tasked with managing exposure to currency risk. Your portfolio has significant allocations in Euro-denominated assets and USD-denominated liabilities. Given the current forward rate for the EUR/USD pair is 1.10, you are considering a hedge using currency options to mitigate potential losses from a potential depreciation of the Euro against the US Dollar.

After conducting thorough analysis, you narrow down your strategy to three possible currency option strategies:

1. Purchasing a Euro put option to establish a right to sell Euros at the current forward rate.

2. Selling Euro call options against your Euro holdings to generate income while risking obligation to sell Euros if the Euro appreciates.

3. Purchasing a mix of Euro put options and Euro call options (straddle) to profit from large moves in either direction while providing protection on both ends.

Which of the three strategies would best accomplish your objective of hedging against Euro depreciation while managing risk?

Purchasing a Euro put option to establish a right to sell Euros at the current forward rate.

Selling Euro call options against your Euro holdings to generate income while risking obligation to sell Euros if the Euro appreciates.

Purchasing a mix of Euro put options and Euro call options (straddle) to profit from large moves in either direction while providing protection on both ends.

Hint

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