Ahh got it, I got off track because I was thinking about "how much" exposure but you mentioned "how" to hedge it. Futures are fun. In terms of actual hedging, I probably won't do much unless it grows to the size of a currency contract (though I could use micros). I'm more just going through the process of dotting i's and crossing t's in system design and risk management at the moment. Making sure I understand the negative possibilities. If the practical nature of the hedging is not granular and the risk to account is only 1-2% it's not an issue.
To answer this question specifically: you indicate that you have an account with IB. This is always a multi-currency account. This means that IB will NOT convert any foreign currency into USD for you. You have to place forex trades to convert from one currency into another. For example: If you lose money after closing a JPY denominated futures contract it will appear in your account as a negative JPY cash position. While you have this futures position open IB will charge you a JPY debit for the margin requirements, unless you already have a sufficiently positive JPY cash amount. Same for all other currencies they support. Each currency will be treated independently. Your so-called base currency is only used for the monthly reports IB sends you. In those reports are the foreign currencies converted to your base currency (in your case USD).
Great thanks. I trade some Canadian & Australian stocks so it sounds like it's similar (except it won't debit/credit me the whole cash value like it does with stocks, just the difference).
Yes, and yes. You will end up with CAD and AUD cash positions. It is then up to you if you want to keep these positions, or that you want to submit a forex order to close these positions and convert them to USD (or any other currency). Of course would you need to pay commission on these forex orders, so you'll want to compare that to the cost of keeping those cash positions. And on your monthly report you will get to see a debit interest charged in these currencies as IB gives you a loan for the maintenance margin for the positions in these currencies. These debit interest charges are reported by IB with a one month delay, so they might pop up later than you would expect.
My take on this is this: 1. A futures contract is equivalent to a long position in the index and an implied negative cash position in the currency of the index. That means your notional value is implicitly hedged with respect to currency fluctuations. 2. To hedge your expected profits (or losses) from the futures contract in the foreign currency, you would basically have to do stochastic calculus, which would be the same calculus as for the valuation of "quanto" derivatives, which commonly depends on the correlations (as opposed to actual exchange rates) between index and fx, if you do the math. This effect is much smaller than the currency effect of an actual unhedged equities position would be; so you might choose to ignore it and to not hedge it. I also don't know how you could possibly hedge changes in correlations, even if you wanted to. P.S.: What I said above in bullet point (1.) pertains to foreign equity index futures. With foreign currency denominated STIR futures you don't have currency exposure in the amount of your notional value in the first place (if "notional value" can be consistently defined at all for STIR futures which I think it can't be). With foreign treasury futures (e.g. BUND futures) you would have exposure to foreign currency bonds, and an implied negative cash position in the foreign currency, which means the foreign currency exposure nets to zero, if I'm not mistaken.
This thread is in the forum section titled "commodity futures". I was not considering stock index or bond futures when I read the OP's questions.
Fair enough. Somebody above mentioned STIR futures. I don't know much about commodity futures, but I think the same logic as for equity index futures would apply, as your economic exposure arising from the commodity futures contract would be long the commodity (measured in the currency that the contract is denominated in) and short cash in whatever currency the future is denominated, right? Which after netting, would result in no effective currency exposure from the futures contract, if I'm not mistaken. The question of what exactly you (or the OP) are trying to hedge arises, as commodities are generally real assets and as such not naturally tied to any currency.
Thanks, had to read these twice but that's actually a great way to put it. Agree with your 2nd point too, not worth hedging I think. It seems it's better just to manage the positive or negative cash balance that ends up in your account, at least with IB the way they pay you daily that would make sense. I think it doesn't really matter what it is. The contract is just a bet on the price series going one direction or another. So whether it is a STIRs contract, or an equity index contract, or a commodity, no currency balance is implicitly owed by taking on the position (other than daily margin M2M P&L that hits your account). I think this was the key understanding I missed when starting this thread, if no foreign currency balance is taken or owed by either party, then forex risk on the total notional value of the contract is experienced by either side. I think it's actually the same, based on what I wrote above. Commodities are just as important to me. Even if interest rates from STIRs were to have some effect on the exchange rate, correlations etc, there's still no foreign exchange exposure to the total notional value of the contract (points * pointCost). That is universal I believe, for futures. The only time it wouldn't be, would be in the case it gapped down to zero or to the moon and you were liable for the whole lot (because only the p&L is exposed to forex). In that case there are bigger problems!
Theory can only teach me so much. I now have a foreign contract position in Palm Oil, and as luck would have it there's some profit on the first day. Now I really do have some forex exposure Those MYR not worth that much though, not worth hedging. Going forward as I get new signals for foreign contracts, I might do a once/monthly conversion back and forth to base currency. I'll track the stats and see how it goes.
No offence, but this isn't true. First, a foreign index future (example: NIY) represents an implicit long position in the currency of the contract denomination. Can't buy the index without the yen! It does, however, represent a relative value trade between the contract and the currency. If you are short the contract, you are still long yen and implicitly short the equivalent USD amount! In other words, the contract is long the currency and the equity exposure. If it was "implicitly hedged with respect to currency fluctuations" then it would be short a basket of currency against the yen. In total, you will have the contract notional value worth of diversified Japanese equity risk, an implicit long position in yen, and no hedge at all for that fx exposure. You are in effect short the US dollar amount of the contract denominated in yen. Put simply, you're either short the dollar and long the index, or short the dollar and long yen against the index.