You are free to re-define terminology and to re-phrase and re-slice basic math in whatever way you like; it makes my head spin. None of that changes the basic fact that a foreign currency equity index future is the economic equivalent to a long position in the equities and a negative cash position in the currency the contract is denominated in, which is a currency hedge in the common sense of the word for a U.S. based (or any other non-Japanese) international equity investor. I stand by what I said.
Sorry to keep requoting you, really. I'm just trying to write simply because people might get confused. Please don't feel any need to respond further. I just want to point out that the contract I used as an example is NIY which is the globex yen denominated. Think of it as a trade where you buy stocks with yen. Then the yen can go up or down, and the stocks can go up or down as well. When you buy this contract, you have exposure to both the value of the yen and the value of the stock index. The contract is settled in yen. The risk is in yen. I hope this is clear enough.
I thought everything was already clear. But now after this it's not clear anymore So when you're saying we have exposure to Yen, it looks like you're not just talking about on the margin and daily mark to market and you're actually talking about the contract value? Are you saying that even if the stock index price did not change, like for example the exchange rate of Yen got cut in half then we'd lose money based on only the exchange rate change? How much exposure exactly? If for example the contract value (full notional) on entry is the yen equivalent $100k USD, are you saying a halving in the Yen exchange rate would cost us $50k even if the stock index price didn't move?
Dude, if you go to https://www.cmegroup.com/education/featured-reports/nikkei-225-spread-opportunities.html and read about the quanto dollar denominated contract, they talk about the correlation and possible spread trades. There is a reason they have both dollar and yen versions of the index. NIY has a 500 yen multiplier, so the value of the contract at the time of this writing is in excess of 19.3 million JPY -- or about 122k USD. Let me ask you this. Now that you know it's trading for over 19 million yen (worth of USD), do you think buying or selling the contract will carry exchange rate risk? That's a trick question. [Note: My earlier post was wrong, it should read: You're either long the yen denominated index against the dollar, or you're long dollars against the foreign denominated index contract.]
The question wasn't IF there was exchange rate risk, the question is how much. What I and others have been saying is that the exchange rate risk is capped at how much your margin+P&L is, so for example if your stop loss is sized at an ATR distance that is $10k USD away from the price, then if the value of the yen halves you could be at risk for up to $20k USD. This is what I understood before your last 2 posts. To me I don't see the point in hedging that, when the market could just as easily go the other direction daily (assuming a 50% win rate). The reason I asked you how much risk, is because your posts are referring to the full value of the contract, not the P&L or the cash balance sitting in our account. I rephrase the previous question I asked to match your example: If for example the contract value (full notional) on entry is the yen equivalent $122k USD, are you saying a halving in the Yen exchange rate would cost us $61k even if the stock index price didn't move? This is not a trick question, I'm really trying to understand more clearly how much exchange rate risk you are warning us about. If my thoughts are wrong, I want to learn why
Sorry I missed that part, I read the link and I think that's a bit out of scope. It just explains that the price series is different due to different denominations. The price series is exposed to the Yen, but the holder of the futures contract does not have forex exposure of the whole notional value of the contract I believe (happy to be proven wrong if I am though). If the holder did have full forex exposure to the notional, then they would lose money if the exchange rate changed even if the price/index of the contract didn't change. Can this happen? The foreign currency affecting the price series is the reason large CTA trend following funds hold multiple versions of contracts for diversification eg ICE US Cocoa, London Cocoa, 3 versions of Coffee, in BRL, Euro, USD etc. Due to the currency the price produces different trends and I don't dispute that. But that's a different subject to the size of the actual forex risk we have in putting on a trade, see my other reply.
Yea. Think about it. You open a long position in USD on the contract. The USD gains 10% on the JPY and the index is unch. You are down 10% on 122k = 12.2k You speculated on a foreign index during a bear market in the domestic currency whatever percentage applied to your opening position. You paid USD to gain exposure, and receive the index * 500yen worth of USD upon closure of the long position (1 lot NIY).
Looking at the contract specs, if the index is unchanged there is no loss because the specs state that the price quotation is yen per index point. That means when the daily or entry/exit mark to market is done, there is no change from the entry position except for commissions. Even if it's denominated in yen, if the index is unchanged then no yen is charged or gained. What you're saying is 100% true for Stocks & ETFs. .But for a futures contract I've never been paid out the index*currency when closing the position. That would be a huge amount of money to put down at the start and receive back at the end. Looking at my current positions I would need 10x the amount of money I'd have in my account to pay for them like that. After starting the thread I did come across something on the CME site that I had not shared, but it's a great explanation so I'll share it now. Please have a look https://www.cmegroup.com/trading/equity-index/intl-investing-currency-risk-in-equity-portfolios.html @tradegoodstocks you were spot on in your explanation - yours is the answer to this whole thread https://www.elitetrader.com/et/thre...ging-currency-risk.381917/page-2#post-6053205
A position in a foreign currency denominated equity index future contract conveys no exposure to currency fluctuations, all other things being equal i.e. when the foreign currency denominated index value doesn't change. Quanto futures (NKD) also don't convey currency exposure (i.e. currency fx delta of zero in options speak), but exposure to the currency/index cross-correlation. In other words, if the realized correlation is different from the implied correlation, then the contract holder will win or lose in addition to the equity index exposure, similar to how the value of equity options changes with changes to the implied volatility and the final result depends on realized volatility vs. implied volatility. Both results can be derived using stochastic calculus by considering a dynamically hedged portfolio (continuously replicating portfolio) using the underlying as a hedge of the futures contracts.