Export Hedge Explained

Last week, I recommended to readers of my personal blog that they buy some Thai Stock Exchange (SET) index call futures and some put options on the Dow. So far, so good: this trade is in the money big time.

I then recommended to readers of Real Money, where I also blog variously, that it would be an interesting morph of the hedge to keep the call futures and buy some put options on the Shanghai Composite Index instead (or alongside the Dow puts). This trade, unfortunately, has not worked out so sweetly: while the SSE has risen to consecutive all-time highs, the SET has been choppy on the back of regional market turmoil and the presently hospitalized Thai King.

This illustrates quite well how two apparently similar-looking trades, when being employed by derivatives instruments, can in fact be entirely different. At their core, these two trades are hedges on the global import/export market: as the US economy weakens, it imports less, meaning the SET - an export-based index - should weaken too, which is where you lose money on the futures. But the Dow should also weaken as the US economy goes sayonara, meaning you hedge out your losses on the Thai futures. If the US economy picks up, the opposite happens.

With the SET-SSE trade, although it looks similar, you are actually betting that export will not decline at all, but will rather shift away from the Chinese market and towards the broader Asia Pacific market as the yuan becomes unsustainable vs. global currencies. In other words, you are long exports, whereas in the other you are hedging exports.

If you mix all the trades together, by buying put options on the Dow and the SSE, and call futures on the SET, you get a different hypotheses: that global exports will decline in general, bringing down the SSE and the Dow (as a knock-on of a weaker economy), but that since the vast concentration of those exports are in China, the effects will resonate minimally to countries like Thailand. Factor in Thai tourism as an "export", and, despite current events, this still looks like a relatively sensible trade.