I think Ackman should be 'correct' one day - but the question is of timing. He might be waiting years (5?!) for this to work out, and the question is what is the opportunity cost in the meantime? But we shall see. Either way it's an interesting discussion with a very smart man.
Email readers will need to come to site to view the video
Summary via FT.com blog:
By automatically importing ultra-loose monetary policy from the US, the peg is contributing to soaring inflation and property prices in the Chinese city.
Ackman is buying Hong Kong dollar call options, which give investors the right to buy the currency at a set price at a specific date, because they are “inexpensive”, according to Bloomberg.
Ackman’s bold call runs contrary to the views of the Hong Kong government and most residents and currency traders in the city, who reckon the peg continues to serve Hong Kong well and should not be changed.
Hong Kong’s exchange rate mechanism, which has survived repeated speculative attacks since its introduction in 1993, allows the Hong Kong dollar to trade in a narrow band from HK$7.75 to HK$7.85 against the US dollar.
Investors like Ackman who reckon the Hong Kong dollar will be allowed to break out of this range can place a wager on their expectation by purchasing Hong Kong dollar call options.
For example, a one-year option to buy the Hong Kong dollar at a strike price of HK$7.75 per US dollar costs 85 basis points, according to Gerrard Katz, head of FX Trading for Asia at BBVA. That means it costs just $8,500 to buy the right to exchange $1m US dollars for HK$7.75m Hong Kong dollars in twelve months time.
In the unlikely event that the Hong Kong dollar was revalued against the US dollar by, say, 30 per cent before the option expired, to a new level of HK$5.96, then the put option would result in a profit of $292,000 – or a 36-fold return on the original investment.
However, the reason these options are cheap in the first place is because the prospect of Hong Kong officials engineering a one-off revaluation against the US dollar is extremely remote. While such a move could, in theory, dampen inflationary pressures, it would also destabilise Hong Kong’s export-driven economy and invite speculative capital inflows.