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Tuesday, February 07, 2023
Seagull Option for Euro Import
*Trading in financial market carries risk and can result in loss of capital.
*This performance is only observed with historical backtests and not traded by the company.
The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.
Risks & Assumptions
Importer Seagull Option
A structure that protects UAE importers of European goods from Euro appreciation while enabling them to capitalize on the Euro’s upside potential at minimal to zero cost.
Profitable when the Euro appreciates; however, importers benefit even if the Euro depreciates as it provides marginal profits to a limited extent.
Potential Savings for UAE Importers with a 200-basis point move
A UAE importer with a position of EUR 10 million can earn a potential profit of EUR 183,396.55 if the Euro appreciates relative to the US Dollar by 200 basis points. This is equivalent to a potential profit of AED 732,005.93 based on the current EUR/AED exchange rate of 3.9976.
Let us see how it happens:
|EUR/USD Spot||Potential Payoff|
Data Source: Bloomberg
Data Source: Bloomberg
The Call Seagull strategy, popularly known as Importer Seagull, is a three-legged strategy that safeguards importers by limiting the downside from adverse movements in exchange rates, while allowing them to capture the upside from favorable fluctuations.
It entails buying one call option and selling two options of which one is a call option with a higher strike price and the other is a put option with a lower strike price. All three options have the same expiry and notional value.
It is very inexpensive because the premium received for selling the call and put options compensates for the premium paid towards purchasing the call option.
Consider a case where a UAE importer is importing automobiles from Europe wherein the EUR/USD spot rate is 1.0900. In order to safeguard against exposure to the EUR payable, the UAE importer enters an Importer Seagull strategy by purchasing a call option with a strike price of 1.0900 while shorting another call option and a put option with strike prices of 1.1100 and 1.0700, respectively.
What happens if the EUR appreciates?
The long call option serves as a hedge against the EUR/USD rate appreciating above its strike price. Movements above 1.0900 up to 1.1100 will yield a payoff that compensates for the higher import costs.
The short call option levies a cap on profits if the EUR/USD appreciates above its strike price. Movements above 1.1100 will yield gains that are capped.
What happens if the EUR depreciates?
The short put option limits the downside in the event the EUR/USD rate depreciates below its strike price. Movements below 1.0700 will make the strategy unprofitable; however, the importer still benefits by incurring lower import costs.
Risks and Assumptions for Back-tested trading strategies
Data Source: Bloomberg
Arun Leslie John
Chief Market Analyst
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