Currency hedging for businesses is widely available but poorly understood. The UK foreign exchange market sees an eye-watering $4 trillion or so in daily FX trades1, largely thanks to London’s position as the global centre for FX trading. The majority of that pie is divided between Spot FX, Forwards and Options, which together form the three key financial instruments for FX transacting and hedging.
Currency hedging for businesses is under-utilised by UK corporates. According to the Bank of England2, 59% of FX transactions are Spot FX – i.e. un-hedged – transactions, with Forwards comprising a quarter of the total and Options 15%.
Research by Bibby Financial Services points towards an FX education shortfall among UK SMEs, with some 70% of UK companies relying on traditional banks for FX3. This matters because pricing structures, service models and levels of advisory support vary significantly between traditional banks and specialist FX providers, a factor cited in the Bibby research as contributing to FX losses across UK SMEs. The current turbulence in FX markets, driven by erratic US trade and fiscal policy and other geopolitical disruption, and an overreliance of Spot FX contribute to an average loss of £17,0004 across all sectors of the UK economy.
While understanding of FX is far from the only barrier to greater uptake of hedging services among UK SMEs, this article will explain the use cases of the three core FX instruments, and aims to give confidence to our readership who are in the group of SMEs over-reliant on Spot FX.
The role of Spot FX in currency hedging for businesses
Spot FX is the immediate exchange of one currency for another at the current market rate for near-instant settlement. If you need a foreign currency, Spot FX lets you get it when that need arises. The option is always there, so there’s no requirement to plan ahead. It’s this convenience that makes Spot FX the biggest form of currency exchange.
You might expect that the convenience of Spot FX must mean it carries a premium, but that’s not always the case. Costs are based on the merchant type. Traditional banks aren’t optimised to compete on margin, so might offer margin in the range of 2-4% – that would be fairly described as expensive compared to other providers. Alternatively, specialist FX brokers and automated FX platforms typically operate on tighter margins (though pricing varies between providers and depends on transaction size, currency pair and market conditions), allowing for the potential to bring FX costs down sharply.
So if Spot FX is cheap and readily available, what’s the downside?
In business, it’s common practice to agree a price and then settle up at a later date – let’s say 90 days – such as after delivery of services or a shipment of goods. But over those 90 days, the cost of currency will fluctuate unpredictably. If euros become more expensive, the agreed price will be more expensive in practice, leading to profit margin erosion. In short, even if the action of tapping the Spot FX market carries little cost per se, it’s that exposure to volatility that’s a problem.
Below a certain level of exposure, random FX movements tend to balance out over time. Above that level, businesses may want to consider whether Spot FX alone meets their needs.
Worked example
A UK business needs to renew a software license from a US provider for $10,000. Because the amount is small and the payment is due immediately, the FD executes a Spot trade. They accept the mid-market rate plus a small spread, settling the transaction within the hour. No future risk exists because the transaction is closed instantly.
The Verdict
Spot FX may be appropriate for immediate settlement requirements or where exchange rate movements are unlikely to materially affect commercial outcomes. If you’re paying for an item today that you discovered you needed yesterday, Spot may be an appropriate instrument.
How businesses use Forwards for currency hedging
Note: FX forwards can help to manage exchange rate risk, but they also create obligations, may involve margin requirements and remove the chance to benefit if exchange rates move favourably.
Forwards are the most widely used instrument in currency hedging for businesses. A forward contract allows a business to secure an exchange rate today for a transaction that will settle on a specific date in the future. It’s a legally binding obligation to trade, meaning that once the rate is locked, the business is committed to it regardless of how the market moves before the settlement date. This allows a company to secure a known exchange rate for a future transaction, though the business remains obligated to transact at that rate even if the market later moves more favourably.
While Spot FX can be accessed via a wide range of financial institutions, Forwards are typically booked through specialist providers. This is because Forwards have additional complexities and counterparty risk compared to the simplicity of Spot FX:
- A Forward requires a margin, or deposit (usually 5-10% of the total). This cash is tied up for the duration of the contract, which can have liquidity implications
- Sharp corrections in FX markets can result in a “margin call”, which is a request for additional funds should your forward contract deposit decrease in value below a certain point. Unrealised losses require a top up to cover the counterparty’s risk
Forwards also require a greater level of planning. Most companies choose not to hedge all their FX exposure because it ties up working capital, creates rigidity in commercial planning and denies a company the opportunity to benefit from favourable market movements. The amount they hedge is called the hedge ratio.
Layered and rolling forwards
There are also more sophisticated and flexible ways of using Forwards.
Layered hedging, which is the incremental purchase of chunks of exposure over time, is a way of smoothing out your average exchange rate over a period. A Forward can be booked at an acceptable, but poor, exchange rate. Layered hedging is a way of building a weighted average rate that is less susceptible to a single particularly poor day, and is normally used for a single large invoice.
Rolling hedging is a hedging programme in which an FX platform automatically books new forwards as old ones expire, keeping a consistent hedge ratio across a moving horizon. Companies often use a rolling hedge programme for recurring costs like payroll or monthly supplies.
Companies need to find an optimal hedging strategy that suits their circumstances.
Worked example
A construction firm signs a contract to buy German machinery for €500,000, payable in six months. To stabilise their project budget, the FD secures a Forward contract at 1.18. Even if the pound weakens to 1.14 by the time the machinery arrives (making the purchase more expensive in pounds), the firm’s cost remains fixed at £424,000. By fixing the exchange rate, the FD protected the project budget from a £15,000 increase that would otherwise have hit margins.
If the FD had not signed a Forward contract, instead deciding to buy €500,000 on the Spot market when the payable is due, the FD could benefit from any strengthening of the pound, or face a higher bill if the pound weakens. A Forward trades both upside and downside risk for certainty.
The Verdict
Forwards are commonly used when exposure is predictable and budget certainty is the priority.They help manage fixed future costs such as equipment purchases, regular overseas payroll or quarterly supplier invoices.
For a deeper dive into the mechanics and variations of these instruments, see our guide, “What is an FX forward contract? A guide for finance directors”.
FX Options: flexible currency hedging for businesses
Note: FX options involve risk. The premium paid is not recoverable if the Option is not exercised.
The last of the main three FX instruments is the FX Option. FX Options are more complex instruments designed for businesses that want some downside protection while retaining the ability to benefit from favourable market movements, this with the cost of an upfront premium.
An FX Option lets you exchange currency at a set rate on a future date, but, unlike a Forward, you don’t have to. If the rate has improved, you can let the Option expire and carry out a Spot transaction at the improved rate.
This flexibility comes at a cost: a non-refundable upfront premium. The premium is the cost of obtaining both certainty and the participation in potential upside.
If it sounds like an Option is a gamble on currency movements versus the cost of the Option. FX Options can be used speculatively, but that’s not the use case Alt21 supports. We focus on risk management for businesses, using Options to manage currency exposure, not to bet on market direction.
The FX Options use case for SMEs is when a bill isn’t a known, but a potential. Bidding on a tender, for instance, is a situation where you may or may not want to complete the transaction, depending on the outcome of the bidding process. The obligation attached to a Forward makes it unsuited to this situation.
You might also use an Option if your customers are price sensitive. If you lock in a rate with a Forward, a competitor who is more willing to risk it on the Spot FX markets might be able to undercut you, if the price falls. An Option lets you secure a worst-case rate without committing to it, which can matter when pricing competitiveness is a commercial consideration.”
Worked example
A UK consultancy bids on a project in Canada worth CAD$1,000,000. They won’t know if they have won the bid for three months. The FD purchases an FX option to secure a minimum rate for the Canadian dollars. If they win the bid and the pound has weakened, they exercise the Option to lock in their margin. If they lose the bid, or if the pound strengthens significantly, they simply let the Option lapse. The cost of the premium is treated as a strategic insurance expense.
The Verdict
Options are particularly well-suited to situations where currency exposure exists but the final outcome is uncertain. This is common when bidding on international tenders or providing project quotes in a foreign currency. An Option means that if you win the contract, your worst-case rate is already secured, but if you don’t win, your only loss is the premium paid.
Choosing the right currency hedging framework for your business
To finish, a quick reminder on the three instruments covered are often used:
- Spot FX – for small transactions, settled immediately
- Forwards – to make a future cost known
- Options – for an uncertain outcome
For businesses with material foreign currency exposure, the move from reactive Spot FX to structured currency hedging for businesses is often as much a mindset shift as a technical one. As a business grows and the volume of foreign currency payments increases, exposure to FX volatility grows with it and how that exposure is managed becomes a strategic question.
The good news is that it doesn’t have to be complicated, or flawless in execution from the outset. A common approach is to use Forwards for predictable costs and Options for contingent ones, building a framework that reflects the business’s specific exposures and risk appetite.
Automated FX platforms like Alt21 give finance teams a single dashboard to manage Spot conversions, book Forwards, and hold Options without the complexity of a traditional bank relationship.
Before committing to any FX product, businesses should ensure they understand the relevant risks, costs and contractual obligations.
If you’re ready, get started with Alt21 today.
1. https://www.bestbrokers.com/forex-trading/forex-daily-trading-volume/
2. https://www.bestbrokers.com/forex-trading/forex-daily-trading-volume/
3. Trading Places: UK SMEs Navigating International Trade in 2025’ Bibby Financial Services
4. ‘Trading Places: UK SMEs Navigating International Trade in 2025’ Bibby Financial Services
5. https://www.santander.co.uk/business/support/payments/making-international-payments
ALT 21 Limited is authorised and regulated by the Financial Conduct Authority (FRN: 783837) and is a company registered in England and Wales (number 10723112). The registered address is 45 Eagle Street, London WC1R 4FS, United Kingdom. This article has been produced by ALT 21 Limited for information purposes only. It does not constitute financial advice or an offer to sell or the solicitation of an offer to buy any products referenced. Hedging products are not suitable for every business. Before entering into any FX product, you should consider whether it is appropriate for your needs and circumstances. ALT 21 Limited assumes no liability for errors, inaccuracies or omissions. Eligibility criteria and terms and conditions apply to all products and services offered by ALT 21 Limited. Not all applications will be accepted.
