Currency Option Trading Strategies as an Alternative Tool for Central Bank Foreign Exchange Interventions

Many emerging markets' central banks are concerned with excessive volatility in foreign exchange rates and intervene to smooth volatility. This paper proposes a specific option trading strategy as an alternative central bank tool to aid foreign currency intervention, where dynamic delta hedging of the net portfolio position guides the central bank's intervention in the spot market. We term this trading strategy the "W" spread, and show that the exchange rate can be stabilized and volatility lowered with this market-driven approach to foreign exchange intervention.