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Please be advised that the hedging sentiments signify the weakness in AUDUSD, as a result, the OTM puts seem relatively costlier than OTM calls. So what could be the alternative..? Are you ready to leave the AUD exposures open..?
Plain vanilla options are a natural instrument for hedging the risk associated with a portfolio of assets. Contrary to a forward contract, where upside potential is capped, options allow an investor to benefit from large increases in the underlying assets, in exchange for a cost, fixed at inception (the premium of the option itself).
However, the main problem an investor faces when dealing with long-volatility positions is the high cost of carry they are normally associated with, especially when volatility levels and options risk premia (linked to the differential between implied and realised vols) are elevated.
Assessing the sensitivity of expected performance of the hedging positions on the moneyness and maturity of the options traded is another important aspect. We start by testing the performance of long volatility strategies in FX, implemented via plain vanilla put options, on AUDUSD.
Aussie is a good example of a proxy for a long-only position in the FX market. Its high level of interest rates has implied its frequent inclusion as a long position in thematic FX Carry baskets. Its high beta, comparable to that of some EM currencies, on the other hand, well simulates the behaviour of an asset which is expected to undergo large declines during crisis periods, potentially over short periods of time.
The chart below demonstrates the performance of a set of strategies rolling 1y maturity puts on AUDUSD, as a function of the delta of the options. Delta-hedging is not implemented, as here the goal is to use options as hedging instruments, rather than a way for arbitraging a mismatch between implied and realised volatilities.
From the chart we see that the performance of 10delta and 25delta puts is quite satisfactory, offering a good level of protection when volatility spikes and a contained cost of carry. The high (and negative) theta of the 50 delta put makes it a less appealing candidate for hedging positions in this case.
