OTC Derivatives Trading
Summary: Vols continue to trade soft but risk reversals have not been marked lower in line with the selloff in AMT vols for all currency pairs. This opens for some trade opportunities in for example USDMXN.
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.
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
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.
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As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
