Steel Industry - Benefits of hedging through options

• XYZ, an exporter, was expecting an inflow of USD 2.50 mn in the first week of December 2018 i.e. two months later (as of October 2018).
• These receivables were not hedged and USDINR was trading at an all-time high of 74.
• Macro-economic factors such as US sanctions on Iran on 4th November, US midterm election results on 6th November, and US-China Trade War were yet to play out and were the key risk events.

Challenge and Observation

• Client Expectation: XYZ wanted to lock the downside risk while maintaining upside participation.
• Uncertain Factors: US sanctions, midterm elections, oil prices, and Sino-US trade war.

Observation: 

• IFA Global believed that most of the negativity (for the Rupee) was already priced in and expected consolidation between 72-74 levels. IFA Global wanted to safeguard the exporter’s interest accordingly.

Process

• IFA Global analyzed the exporter’s costing and accordingly recommended a strategy to hedge the risk.
• The option strategy with appropriate strike price and expiry was devised for X.
• XYZ was advised to hedge these exports using the above-formulated option strategy.

Outcome

• The US provided waivers from sanctions to eight countries which brought about a 35% correction in oil prices in December.
• US and China agreed to renew their trade talks at the G-20 Summit, thus appreciating the Chinese Yuan to 6.884 levels from earlier highs observed at 6.97 levels.
• All these factors brought about appreciation in the Rupee and it traded at 69-70 levels.
• Due to our recommendation, XYZ had Rupee realizations of export inflows that were almost 3.50% higher than the Spot market rates then.