Using Seagulls to hedge forex risk

The new year has dawned and the central theme for financial markets has been US dollars strength (this has continued since Trumps victory on 8Nov16). The US President-elect has been promising to bring about substantial changes to “make America great again”. Lot of promises (his press conference a few days back was combative and he was in full control). Well, election promises and actual deliverance are two completely different things (our honourable Prime Minister will certainly vouch for this).
 
In this widespread circumstance of dollar strength, rupee has been stable around the 68 mark (high-low range of 67.70 – 68.35) since 15-Dec-2016. Rupee holding above the 68 mark puts some kind of a psychological pressure on exporters (and importers alike), with a feeling that rupee is weak. Levels around 67 are fine, but 68+ levels are a sign of rupee weakness. Is this really true?
Analyze this – rupee spot was around 67.50 as on 15-Jan-2016 – indicating that since then it has weakened only about 1% (or 60-70 paise per USD) – while forward premiums at that time was in excess of 6% (or 400 paise per USD). Effectively meaning that despite levels above 68, rupee is not really weak.
 
Mr. Victor – enough of history. Tell me, how do we hedge?
 
For exporters: do some forwards (about 30-40% of total exposures). 4.5% annualized premiums fetches a forward rate in excess of 71.10 for Jan-2018 (not bad, isnt it?). One should certainly use options as well.
A Seagull option looks good now (for 1-year maturity):
Buy USD Put at 70.75 (near the current forward rate)
Sell USD Call at 73
Sell USD Put at 67.50
In the above option structure, our risk arises if rupee weakens above 73 (7% rupee weakening in a years time – an unlikely scenario) or if rupee gains below 67.50 (1% rupee appreciation after 1 year – this looks unlikely too). In the rare case that rupee does gain beyond 67.50 after one year, you are still protected and will gain Rs. 3.25 per dollar (70.75 – 67.50) from the market rate.

Spot at Maturity

Sell USD Put 67.50

Buy USD Put 70.75

Sell USD Call 73.00

Net Effective Rate

65.00

67.50

70.75

Not exercised

68.25

66.00

67.50

70.75

Not exercised

69.25

67.00

67.50

70.75

Not exercised

70.25

68.00

Not exercised

70.75

Not exercised

70.75

69.00

Not exercised

70.75

Not exercised

70.75

70.00

Not exercised

70.75

Not exercised

70.75

71.00

Not exercised

Not exercised

Not exercised

71.00

72.00

Not exercised

Not exercised

Not exercised

72.00

73.00

Not exercised

Not exercised

Not exercised

73.00

74.00

Not exercised

Not exercised

73.00

73.00

75.00

Not exercised

Not exercised

73.00

73.00

76.00

Not exercised

Not exercised

73.00

73.00

 
For importers: if rupee recovers towards 67.50-80, start hedging for 1-2 months. Consider using options too.