Hello and welcome to this installment of "Derivatives Demystified."
Today I am writing about using spot forex orders to manage my currency risk instead of a derivative. In my example, I am not required to import, and I am not mandated to hedge exposures. However, I will import when market conditions are favorable.
Yesterday, I had an el fresco-style lunch under the beautiful African summer sun in Sandton. A once bustling restaurant where finding a lunchtime seat without a prior booking was unfathomable.
Now, post Covid, post the migrations to home offices or Cape Town, the restaurant was empty.
My friend Steve helped me reflect on how much everything has changed since the pandemic. We are less fickle and now value things like health and family. Or is that untrue? Many things seem back to normal, and we appear to love Louis Vuitton more than ever. My word, the LVMH share price has nearly doubled over the past two years! The Arnault family is richer than ever and richer than everyone. Some suggest a phenomenon called comfort buying. Normally (whatever that is) more luxury goods are bought when income rises. In contrast, the current phenomenon means buying luxury goods even when your income is stable or declining. Economics professors everywhere are deleting slides on high income elasticity of demand.
Whatever it is, we're not stopping. So lather me in Givenchy and cover me with Loewe. Drown me in Hennessy and decorate me with Tiff. In short, I need euros!
EURZAR is trading at 18.72, a 250 cent slip over the past year. In the written format of a EURZAR exchange rate, the EUR refers to the base currency (or simply currency) and the ZAR refers to the counter currency. If the counter currency happens to be the currency you report in, you could call it the reporting or functional currency. And if the counter currency happens to be the currency of your country, you would refer to it as your local currency. So you would pay 18 rands to buy 1 euro.
18.72 is too high. My salary can't pay these levels. So which derivatives strategy do I employ? A good one is a participation forward. I wrote a post about this structure before and still like it.
Or I could leave a spot order to buy. Say at 18.00.
The language I would use when speaking to my banker is: I want to leave a take-profit order at 18.00. If I leave an order to buy currency at a level below the current exchange rate it is called a take-profit order. If I leave an order to buy currency above the current exchange rate it is called a stop-loss order. There are various types of orders, but the most common type will be watched until it is filled (called a GTC or good till cancelled order) and it will be filled in portions when the market trades through my level until the full size is achieved. There might often be a small difference (called slippage) between my level and where I am filled. Slippage happens if the market jumps through my level without there ever being a firm price to the exact decimal that I stipulated.
If EURZAR trades back to 18.00, Investec will fill my order, and I will buy EUR. And with those euros, I will buy happiness.
Alternatively, if EURZAR continues to trade around these levels or higher, well, then I'll make peace with the fact that I don't have oil money. So instead, I'll buy pre-loved Vuitton's.
I'll remember what life is all about, that time is fleeting, that health is more important than anything and that I'm lucky to have survived a pandemic.