FXO Market Update - Feb 11

Vols continue to trade offered with equities grinding higher as market trades in a risk on mode. Vols are trading lower in a weighted fashion where short dated are marked lower more than the backend vols.

While ATM vols trades offered we see skew trade lower as well, but the selloff in the skew is lagging in some currency pairs. Taking a closer look at USDMXN, we can see that the 1 month risk reversal vs ATM vol ratio trades at historically high levels. Meaning that the risk reversal is very high compared to where the ATM vol is trading. This ratio has only been higher during the US election in 2016 and during the peak of the pandemic in March/April last year and just on a few other short periods since 2016.

This means that USDMXN calls are priced very high compared to ATM and USMXN puts trades with a big discount compared to ATM.

Depending on your view on USDMXN. Buying USDMXN puts or selling calls, either on its own or as a risk reversal, takes advantage of the current expensive skew for a trade lower in USDMXN. If you think USDMXN will trade higher then call spreads offer good value.

Lower USDMXN:

Buy 1 month 19.9000 USDMXN put
Cost 1950 pips

Sell 1 month 20.8000 USDMXN call
Receive 900 pips

Higher USDMXN:

Buy 1 month 20.2000 USDMXN call
Sell 1 month 20.8000 USDMXN call
Cost 1675 pips

Or cost 750 pips if done with a 1 by 2 ratio.

Spot ref. 19.9950

• 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.

Learn more about FX Options:

Forex Options – An introduction

Forex Options – Exotic options