Hedging FX Exposure with Mexican Peso Futures

From Global Markets to Local Currency: Hedging Your International Equity Portfolio

Investors seeking diversification and exposure to emerging market growth may find the Mexican equity market to be an attractive destination. The S&P/BMV IPC, as the primary market index, provides a benchmark for the performance of the largest and most liquid companies in the country.

The E-mini S&P/BMV IPC futures contract offers a capital-efficient and streamlined method to gain access to this market. This instrument is particularly valuable for its ability to allow for flexible, precise management of exposure, whether the goal is to hedge existing risk, diversify a portfolio or capture growth in the Mexican economy.

A U.S.-based investor in a foreign, local-currency-denominated asset faces a complex risk profile. The total return on such an investment is not solely dependent on the performance of the underlying asset but also on the fluctuations of the foreign exchange rate between the two currencies. The investor is simultaneously long the local equity market and long the local currency.

A favorable movement in the equity index can be offset, or even entirely negated, by an adverse movement in the exchange rate, and conversely, a negative equity market can be compounded by an unfavorable currency movement.

The hedging instruments: Futures contracts

The proposed hedging strategy utilizes two distinct, yet complementary, CME Group contracts: the E-mini S&P/BMV IPC futures for the primary exposure and the Mexican Peso futures as the hedging vehicle.

The primary position: E-mini S&P/BMV IPC futures (IPC)

The E-mini S&P/BMV IPC futures contract (IPC) is designed to provide broad exposure to the 35 leading stocks on the Bolsa Mexicana de Valores (BMV). The notional value of a single IPC contract is determined by multiplying the index level by the contract unit. For example, at an index level of 61,000, one contract's notional value is 61,000 x 5 MXN, or 305,000 MXN.

The hedging tool: Mexican Peso futures (MP)

To manage the currency exposure, the U.S. investor will use the Mexican Peso futures contract.

Mechanics of a cross-asset FX hedge

The objective is to synthetically create a U.S. dollar-denominated investment in the S&P/BMV IPC Index to neutralize the foreign exchange risk and allow the portfolio's performance to be driven primarily by the movements of the underlying Mexican equities. The strategy is a form of cross-hedging, as the hedged asset (Equity Index futures) and the hedging instrument (currency futures) are distinct but highly correlated.

The strategy consists of a long position in the E-mini S&P/BMV IPC futures contract and an offsetting short position in the Mexican Peso futures contract. The long IPC position gives the investor exposure to the Mexican equity market, but its value is expressed in MXN. To neutralize this embedded long MXN exposure, the investor must sell an equivalent notional amount of Mexican Peso futures. This short position will generate a profit if the MXN depreciates against the USD, which will then offset the loss that would have occurred when the IPC futures' notional value is converted back to USD. Conversely, if the MXN appreciates, the loss on the short MXN futures will be offset by the currency gain on the IPC position. The net result is that the portfolio's value is insulated from fluctuations in the MXN/USD exchange rate.

A significant advantage of this futures-based hedging strategy is its capital efficiency. By using futures contracts, an investor can control a large notional position with a relatively small amount of capital in the form of initial margin. This allows the investor to use a smaller amount of capital to establish a hedge for a large portfolio, enhancing the return on invested capital.

A detailed hedging example and P&L analysis

A U.S. investor has a portfolio valued at approximately $1.69 million, which is invested in the S&P/BMV IPC. To gain this exposure, the investor buys 100 E-mini S&P/BMV IPC futures contracts.

Initial market data

• S&P/BMV IPC Index level: 61,000 points.
• IPC futures price: 61,000.
• USD/MXN exchange rate (spot): 18.00 MXN/USD.
• MXN futures price: $0.05555 USD/MXN (equivalent to 1/18.00).

The total notional value of the long IPC position is calculated as:

100 contracts×61,000 points/contract×5 MXN/point=30,500,000 MXN.

This translates to a USD value of:

30,500,000 MXN / 18.00 MXN/USD = $1,694,444.44

Calculation of the hedge

To hedge the foreign exchange risk, the investor must short the number of Mexican Peso futures contracts that matches the total notional exposure of the IPC position in MXN. The contract size of a single Mexican Peso futures contract is 500,000 MXN.

The number of MXN futures contracts required is:

• Number of contracts=Total MXN notional/MXN futures contract size​=30,500,000 MXN/500,000 MXN/contract=61 contracts.

The investor shorts 61 Mexican Peso futures contracts.

Performance analysis across scenarios

• Scenario A: Favorable FX movement. The S&P/BMV IPC Index gains by 5%, and the MXN appreciates against the USD. The unhedged position experiences a combined gain of over 10%. The hedged position, however, aims to isolate the equity performance. The loss on the short MXN futures position offsets the currency gain from the IPC position, resulting in a P&L that is much closer to the underlying index's performance. The investor's gain is the index appreciation, but the added gain from the currency movement is captured by the futures loss.
• Scenario B: Unfavorable FX movement. The S&P/BMV IPC Index still gains by 5%, but the MXN depreciates against the USD. The unhedged position sees its entire index gain wiped out by the currency loss, resulting in a net P&L of $0.00. The hedged position, in contrast, benefits from the profit on the short MXN futures position, which offsets the currency-related loss on the IPC notional. The result is a positive P&L, successfully isolating the index's performance. This scenario clearly illustrates the primary purpose of the hedge.
• Scenario C: Index decline with unfavorable FX. The index declines by 5%, and the MXN depreciates by 5%. The unhedged portfolio suffers a substantial loss, as the two adverse movements compound one another. While the hedged portfolio still experiences a loss due to the decline in the underlying index, the profit from the short MXN futures position mitigates a portion of the total loss. The hedge successfully protects against the currency-induced component of the loss.
• Scenario D: Index decline with unfavorable FX. The index declines by 5%, but this time the MXN appreciates by 5%. The unhedged portfolio's loss from the falling index is entirely offset by the currency gain, resulting in a net P&L of $0.00. The hedged position, however, reflects the index loss. The loss on the underlying equity index is compounded by the loss on the short MXN futures position (because the MXN appreciated). This scenario demonstrates that while the hedge successfully insulates the portfolio from the FX movement, it also prevents the investor from benefiting from a favorable currency movement that could have offset the equity loss.

The following table demonstrates the P&L of the hedged and unhedged portfolios under three distinct market scenarios.

The long and short of it

The analysis confirms that a futures-based strategy using the E-mini S&P/BMV IPC futures and the Mexican Peso futures is an effective and robust method for a U.S. investor to isolate the performance of the Mexican equity market from the volatility of the MXN/USD exchange rate. By taking a long position in the equity index and a short position in the currency, the investor can create a synthetic USD-denominated position, effectively neutralizing the dual-risk exposure and allowing the portfolio's return to be driven purely by the underlying index's performance.