FxWirePro: ZAR confronts political pressure as economic pledges are betrayed - hedge via debit call spreads

South Africa's core fundamental risk is governance. Investors are unsure whether President Jacob Zuma will strive to keep fiscal accounts in strong shape. On December 9, Zuma decided to replace a respected appointee, Nhalanhla Nene, with a less known name, David Van Rooyen, to the Minister of Finance seat.

Van Rooyen was seen as inexperienced and less market-friendly. The backdrop for the switch followed several disagreements between Zuma and Nene on funding SAA (South African Airways) plane acquisitions and a potential nuclear energy project.

We believe the dust may settle now but would maintain a bearish bias because headline inflation may increase in the near future on seasonality and the current account deficit remains a concern.

Changing MinFins likely worried investors overexposed to the local bond market. We therefore have forecasted USD/ZAR at 16.50 levels for the end of Q1 of 2016. 

Hedging strategy: Debit call spread (USD/ZAR)

Since we expect USD/ZAR to evidence a vigorous upswings, South Africa's rand deteriorates more than 1% against U.S. dollar to 15.7600 despite positive SA's PPI figures. Today South Africa released PPI data at 1.6% m/m vs 0.2% previous release.

The long term trend being uptrend and we don't want to buck this trend, hence, buy 1M (1%) in the money 0.51 delta call option while shorting 1W (1%) out of the money call option for net debit.

Risk Reward profile: An investor will also turn to this spread when there is discomfort with either the cost of purchasing and holding the long call alone, or with the conviction of his bullish market opinion. Maximum loss for this spread will generally occur as USDZAR declines below the lower strike price. If both options expire out-of-the-money with no value, the entire net debit paid for the spread will be lost.

Please be noted that the tenor shown in the diagram is only demonstration purpose, use appropriate tenor as stated in the strategy.