FxWirePro: Achieve costless hedging for USD/BRL using options seagull

Since mid-September, USDBRL managed to surge well above the 3.20 mark after having traded sideways within a range from 3.10 to 3.20 in the summer.

All in all, the BRL seems to be robust again despite political scandals and rather disappointing developments regarding reform. And thanks to a positive EM market environment, the BRL has also coped well with the strong rate cuts of the Brazilian central bank.

Well, amid all these uncertainties on hedging grounds, we advocate 6m USDBRL topside seagull (strikes 3.10/3.40/3.60):

This option structure is a standard 6m call spread that is partly financed by selling a put strike 3.10 (reduces the cost of the call spread by 70%) and maximum leverage is 8 times (5% gain at expiry).

Three-legged options strategy that involves adding longs in a call spread and shorting a put option with a view to establishing a hedge against adverse movements in the underlying spot FX.

The loss is unlimited below 3.10. Positioning in local rates is very high, supported by disinflationary pressures, BCB easing, high real yields and an improving external position.

However, in 2018, BCB is expected to end its easing cycle and tighten in 4Q’18, while political risks would intensify leading up to the October elections with the nagging issue of pension reform likely unresolved.

This strategy is quite often used in forex markets, where a hedger can hold a seagull option to establish a costless hedge against the appreciation of a given currency within a certain range. However, that won't protect this hedger against a depreciating exchange rate.

For USDBRL to trade meaningfully below the 3.05-3.10 lows on a sustained basis would require a perfect storm of domestic and external factors aligning.