US Elections 2020: FX Options
Election 2020 Mitigating Currency Risk

An FX Options guide to get you through currency volatility during the US election

Disclaimer: This document is for information purposes only and is not in any way offering advice, nor should it be used to offer advice.

Historically, presidential elections have been pivotal in major market moves and we are expecting much of the same this year, including the chaos surrounding COVID-19 and its impact on the running of the elections.

Key Details for the 2020 Election

When is the US 2020 election?

3 November is the official date of the US election.

Who are the candidates?

The Republicans are the conservative political party in the US, President Donald Trump is the candidate for this party, looking to secure another four years in power.

The Democrats are the liberal party in the US, Joe Biden is the candidate here, who is well-known for serving as Barack Obama’s vice president.

When do we know the results?

It can take several days for each vote to be counted, but usually early hours of the next morning (4thNovember), will give the market a clear indication.

The US Elections Impact on Foreign Exchange

Over the course of an election cycle, issues such as international trade, national security, and government spending become focal points of the national discussion. As a result, the financial markets tend to fluctuate and currency volatility is expected before, on and after election day.

The result of the U.S. general election exerts much influence on the institutions of the world, and it’s a major factor in global political and economic landscapes.

Brexit time running out - Keydates

GBP/USD – The last 12 months

Brexit time running out - Keydates

EUR/USD – The last 12 months

The run-up to the elections has caused some volatility in GBP/USD with polls demonstrating a huge amount of uncertainty. Pressure mounting on the UK on the back of rising COVID-19 cases and of course the latest troubles for Boris Johnson in parliament, ahead of another episode of Brexit updates. Resistance on the pair sits around 1.3015 and the pressure continues to weigh on sterling. However, failure to break further through the 1.30 mark during the election build-up could mean plenty of room for a downfall as the UK continues to absorb pressure.
The Democrats candidate - Joe Biden
What can we expect from a Joe Biden win?

The possibility of a Biden win could lead to a weak US dollar in the long-term, according to market analysis. His agenda focuses on tax hikes, reducing consumer spending and opening the US to more international trade with Europe and the Far East as a result of reductions in tariffs. A new leader in most cases does cause uncertainty in the currency of an economy.
The Republicans candidate - Donald Trump
What can we expect from a Donald Trump win?

Retaining the presidency means more of the same from Trump. Market analysis indicates the likelihood of a strong US dollar should Trump take home victory. His aggressive approach with China and Europe on trade relations is likely to continue. Further tax cut proposals in a bid to support public spending and productivity to “Make America Great Again” seems to be the slogan he will stand by.
Actual Historical

Forward

ABN Amro

Barclays

Bank of America Merrill Lynch

Citigroup

Credit Suisse Group

ING Financial Markets

JPMorgan Chase

Lloyds Bank Commercial Banking

Morgan Stanley

GBPUSD forecast Graph Forecast Next 6 Months

Copyright©2020 Bloomberg Finance L.P.
GBP/USD – 6 month forecast

Actual Historical

Forward

ABN Amro

Barclays

Bank of America Merrill Lynch

Citigroup

Credit Suisse Group

ING Financial Markets

JPMorgan Chase

Lloyds Bank Commercial Banking

Morgan Stanley

EURUSD forecast Graph Forecast Next 6 Months

Copyright©2020 Bloomberg Finance L.P.
EUR/USD – 6 month forecast

Mitigating the Risk of Currency Volatility

Options can be highly useful in a volatile market that could go either way, political events such as the US elections are a prime example of this. Where a forward contract offers you 100% protection but no possibility of upside/partaking in movements in your favour, an FX Option allows an opportunity for both.

What is an FX Option

A Vanilla Option is a foreign exchange contract between two parties that gives the holder, or purchaser, of the option the right, but not the obligation, to exchange one currency for another currency, for a specified amount, at a specified exchange rate (known as the strike rate) at a specified date in the future. To purchase this option the buyer pays the seller an upfront premium.

A Vanilla Put Option gives the holder the right to sell the base amount of currency, under the terms specified above.

Advantages
  • Provides full protection from adverse currency movements in the EURUSD exchange rate.
  • Ability to benefit fully from any appreciation of the EURUSD exchange rate.
  • Ability to customize the strike rate to a level that suits your needs.
Disadvantages
  • Premium must be paid upfront

What Happens at the Point Expiry

At the expiry date there are two possible scenarios:

FX Option is less favourable then current Spot
1. Less Favourable
If the spot rate at expiry is less favourable than the strike rate client has the right, but not the obligation, to trade the notional amount at the strike rate.

FX Option is more favourable then current Spot
2. More Favourable
If the spot rate at expiry is more favourable than the strike rate client has no obligation and is free to trade at the market rate.

An Example of a Vanilla Option

John needs to make payments form EUR to USD for stock purchases within in the next 3 months

selling

1,000,000.00 EUR

Spot Rate

1.1850

Buying

USD


Risk Profile

As John is selling EUR and buying USD, his risk is in the EURUSD rate falling from the current spot price of 1.1850, therefore making the products more expensive.

John takes out the FX Option below to de-risk his exposure to exchange rate volatility.
Expiry Date

29 Jan 2021 (3 Months)

Selling

1,000,000.00 EUR

Strike Rate

1.1850

Buying

1,185,000.00 USD

Premium Payable

15,500.00 EUR
or
18,367.50 USD

Just 1.55% of the notional amount

By taking out the Vanilla FX Option above, John can budget the next 3 months of business knowing that if the EURUSD exchange rate moves against him, the most he will pay for their payments has already been locked in. On the other side, if the EURUSD exchange rate improves they can make the most of exchange rate fluctuation and book a spot transfer with no obligation to make the payment with the open FX Option.

for further details why not get in touch

If you have any queries on how we can help mitigate risk with FX Options, or maybe you just want a second opinion on a strategy you’ve already got in place, please follow the link below and schedule a convenient time for me to give you a call.