FXO Market Update - Dec 8
OTC Derivatives Trading
Summary: EURUSD vol trades firm as Brexit trade talks uncertainty increases as we closing in on the end of the transition period.
Saxo Bank publishes two weekly FX Options Market Update reports covering changes and updates on the FX Options and FX Volatility market. They describe changes in FX volatility levels, risk premium and ideas how to trade based on these.
GBP started the week on the backfoot after some negative Brexit trade talk headlines over the weekend and the market is concerned a deal will not be reached before the deadline.
GBPUSD traded down to 1.3225 low after it closed at 1.3440 on Friday. Vols are paid up with 1 month up 1.5 vol to 12.5, the highest level we have seen since March/April. The risk premium has increased further and currently trades around 3.5 vol in both GBPUSD and EURGBP. Risk reversals are paid up after the sharp move lower in spot. 1 month GBPUSD risk reversal trades at 3.5 vol for GBP put, almost at the same levels as the highs in March/April and is up from 0.5 a month ago.
GBP puts have become very expensive with the high risk premium and the high risk reversal. Even if spot could drop below 1.2700 in a scenario of a no deal the probability for a no deal is still relatively low and buying naked puts can be expensive if the expected move does not materialize.
Buying but spreads currently give good discount compared to buying outright puts. 1 month 1.3200 put cost 150 pips while a 1 month 1.3200/1.2700 put spread cost 108 pips. So a 25% discount to the outright 1.3200 put and a risk reward of 4.6.
Alternative a Reverse Knock-Out (RKO) put, which we offer for offline trading, is also cheap due to the high vol and risk reversal. The downside is that if spot moves to far and touch the knock-out the option ceases to exist, and the buyer lose the rights to sell at the strike. 1 month 1.3200 put with 1.2700 Knock-Out cost 35 pips, 1/3 of the put spread, and has a risk reward of 14.2. A lower Knock-Out will be more expensive but decrease the probability to get knocked out. 1 month 1.3200 with Knock-Out at 1.2500 cost 55 pips.
Buy 1 month 1.3200 GBPUSD put
Sell 1 month 1.2700 GBPUSD put
Cost 108 pips
Buy 1 month 1.3200 GBPUSD put RKO 1.2700
Cost 35 pips
Buy 1 month 1.3200 GBPUSD put RKO 1.2500
Cost 55 pips
Spot ref. 1.3365
- The Top/Bottom charts shows the top 5 and bottom 5 values/changes for at-the-money vol, risk reversal (RR) and risk premium of the 45 currency pairs we are tracking.
- Risk premium: Implied (Imp) minus realized volatility. A positive risk premium means implied volatility trades above realized volatility, i.e. the implied volatility can be seen as “rich”.
- Change: The difference between current price/volatility and where it closed 1w ago.
FX Options Trading:
You should be aware that in purchasing Foreign Exchange Options, your potential loss will be the amount of the premium paid for the option, plus any fees or transaction charges that are applicable, should the option not achieve its strike price on the expiry date
If you write an option, the risk involved is considerably higher than buying an option. You may be liable for margin to maintain your position and a loss may be sustained well in excess of the premium received.
By writing an option, you accept a legal obligation to purchase or sell the underlying asset if the option is exercised against you; however far the market price has moved away from the strike. If you already own the underlying asset that you have contracted to sell, your risk will be limited.
If you do not own the underlying asset the risk can be unlimited. Only experienced persons should contemplate writing uncovered options, then only after securing full detail of the applicable conditions and potential risk exposure.