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There’s always a lot of concern and panic when the exchange rate goes up and down – businesses often aren’t taking advantage of the right currency hedging strategies. Find out how a plain vanilla option can protect your bottom line.
Many businesses aren’t taking advantage of the available currency risk management options to protect their profits, particularly if they import from South Africa or export to the UK. There are different types of hedging tools that can help you manage your currency risk. We’re going to focus on the plain vanilla option.
What is a plain vanilla option and how does it work?
A plain vanilla option allows you to pay a premium up front to lock in an exchange rate in the future. This guarantees protection should there be any major fluctuations in the GBP/ZAR exchange rate. A vanilla option gives you the right, but not the obligation, to exchange one currency with another currency at a pre-agreed exchange rate on a specified date in the future.
A key benefit of using a vanilla option over the more popular forward, is that there’s absolutely no obligation to use it if the exchange rate moves in your favour. You only need to act if you suffer an exchange loss.
The table below shows the difference between options and forwards.
|Protected from downside risk||Yes||Yes|
|Gain from upside moves||Yes||No|
|Cash out early||Yes||No|
|Can affect credit limit||No||Yes|
|Obligation to fulfil contract||No for buyers||Yes|
|Price based on current spot rate||Yes||Yes|
|Price based on length of contract||Yes||Yes|
|Flexible settlement dates||Yes||No|
Options protect you and your business against exchange rate movement
Currency options offer infinite upside and limited downside risks, and they’re flexible, often suiting companies who compete for a lot of tenders. They help you gain from upside foreign exchange movement and protect you against any downside risk.
Added flexibility and infinite upside comes at a premium, which some businesses think is too expensive, but the benefits often outweigh the upfront fee that’s required.
Options also allow for early exercise. This lets you exercise an option on any day before its expiry. You can activate the option and convert the currency at the pre-agreed rate.
Here’s how options can benefit your business:
ABC Corporation is a UK company with its subsidiary in South Africa. The company has several employees in its South African office. At the end of every month, they pay their employees’ salaries in Rands.
The company budgets for their South African payroll a month in advance, which is good practice. In June, the company budgets the payroll at 1 GBP = 18.50 ZAR. The total salary to be sent at the end of the June is R100,000, which costs the company around £5,405.
The company has no protection against rate fluctuations and is not hedging at all. By end of June, when they are about to pay the salaries, £1 is now R17.50. The total salary of R100,000 now costs the company £5,714.
That’s a difference of £309. Had the company hedged at the start of June when they had an option to sell R18.5 with a premium of £89.00, they would have saved nearly £220.
Sable International offers currency options
Currency fluctuations can really take a chunk out of your profits, which is why importers and exporters use currency hedging to protect their profits. Whether you run a big retail company or a small business, you can benefit from currency risk management tools.
Our hedging specialists can tailor the appropriate currency risk management solution for you or your business – helping you protect your profits, reduce your costs and streamline your international payments.
We believe in complete transparency – the rate you see is always the rate you get. We never surprise you with hidden bank charges. Our forex brokers are always on hand to assist you with whatever query you may have.
We specialise in helping businesses develop strategies to manage their currency risks. Get in touch with us on firstname.lastname@example.org or give us a call on +44 (0) 20 7759 7575.
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