Seagull Option for Euro Import
By Century Financial in Investment Insights*Trading in financial market carries risk and can result in loss of capital. *This performance is only observed with historical backtests and not traded by the company.
The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.
Risks & Assumptions
The structure is based on options buying & selling strategy. Option prices and the corresponding pay-off are as of expiry & for representative purposes only. Going ahead, as the stock price moves in either direction, the final pay-off will change accordingly.
The assumption of receipt of the initial coupon or the initial debit cost is based on the option premiums available at structure creation. This may vary at the actual execution time depending on the corresponding option prices and implied volatility.
Numbers given below for the P&L are on a gross basis (without considering any transaction charges). Importer Seagull Option
A structure that protects UAE importers of European goods from Euro appreciation while enabling them to capitalize on the Euro’s upside potential at minimal to zero cost.
Profitable when the Euro appreciates; however, importers benefit even if the Euro depreciates as it provides marginal profits to a limited extent.
Potential Savings for UAE Importers with a 200-basis point move
A UAE importer with a position of EUR 10 million can earn a potential profit of EUR 183,396.55 if the Euro appreciates relative to the US Dollar by 200 basis points. This is equivalent to a potential profit of AED 732,005.93 based on the current EUR/AED exchange rate of 3.9976.
Let us see how it happens:
Data Source: Bloomberg Date: 01/02/2023
Pay-off Profile
Data Source: Bloomberg
Date: 01/02/2023
Features
The Call Seagull strategy, popularly known as Importer Seagull, is a three-legged strategy that safeguards importers by limiting the downside from adverse movements in exchange rates, while allowing them to capture the upside from favorable fluctuations.
It entails buying one call option and selling two options of which one is a call option with a higher strike price and the other is a put option with a lower strike price. All three options have the same expiry and notional value.
It is very inexpensive because the premium received for selling the call and put options compensates for the premium paid towards purchasing the call option.
Illustration
Consider a case where a UAE importer is importing automobiles from Europe wherein the EUR/USD spot rate is 1.0900. In order to safeguard against exposure to the EUR payable, the UAE importer enters an Importer Seagull strategy by purchasing a call option with a strike price of 1.0900 while shorting another call option and a put option with strike prices of 1.1100 and 1.0700, respectively.
What happens if the EUR appreciates?
The long call option serves as a hedge against the EUR/USD rate appreciating above its strike price. Movements above 1.0900 up to 1.1100 will yield a payoff that compensates for the higher import costs.
The short call option levies a cap on profits if the EUR/USD appreciates above its strike price. Movements above 1.1100 will yield gains that are capped.
What happens if the EUR depreciates?
The short put option limits the downside in the event the EUR/USD rate depreciates below its strike price. Movements below 1.0700 will make the strategy unprofitable; however, the importer still benefits by incurring lower import costs.
Risks and Assumptions for Back-tested trading strategies
The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
Unforeseen events can lead to variation in performance from the tested trading strategy.
The tested result has been computed with price feeds available from Bloomberg.
The testing environment has not considered transaction or any other costs.
Trading indicators used for the purpose of testing has been provided by Bloomberg.
The strategy might suffer from data mining fallacy, selection bias and backfill bias.
Data Source: Bloomberg
Data: 18/11/2022
Arun Leslie John Chief Market Analyst