“If you can scrape together $ 1 million,” Ackman said, "you can buy a one-year call option on $200 million in Hong Kong dollars.” Options are priced on volatility, and these ones are cheap, Ackman says, because of the currency peg and stated intentions of officials from Hong Kong’s monetary authority to keep it that way. Those authorities don’t tend to make their decisions far in advance though, so “they can change the game overnight.”
A revaluation against the Chinese yuan may be forthcoming by 2015 or 2016, but between then and now Ackman is convinced that a re-pegging of the trading band against the greenback is the more likely option.
However, there is more logic behind Ackman's trade other than an expectation that the currency band will be re-pegged.
Basically, hedge fund managers think that the Hong Kong dollar has the upside potential of holding U.S. dollars, but the downside risk is limited. Currently, the Hong Kong dollar is pegged at 7.80 HKD per USD. The peg has been in place for ages and most investors have ignored the HKD because it is essentially identical to holding USD.
As most of the world continues to dump euros in favor of dollars, the HKD should be stable and appreciate in lock step with the USD. However, hedge fund managers are most interested in the risk that the USD begins a deep slide due to the mounting U.S. debt.
If the USD were to depreciate by 20% or more, it is most likely that the Hong Kong government will make a one-off revaluation of the peg. In essence, downside exposure can be limited.
It should be noted that Ackman is betting against the CEO of Hong Kong, Donald Tsang, who said that he will lose a lot of money waiting for the peg to be re-adjusted.
“I think he’s going to lose a lot of money on that,” Tsang, said in a Bloomberg Television interview[url=http://topics.bloomberg.com/new-york/][/url]. The peg is a “very important anchor underpinning Hong Kong growth and Hong Kong’s monetary stability and we are not going to change,” he said.