FXO Market Update - Mar 22
OTC Derivatives Trading
Summary: Market has turned focus back to inflation and rates and USD trades higher. USDJPY has taken out the 120.00 level and is up form 115.00 in about 2 weeks. Vol trades bid despite realized not performing with 1 month USDJPY currently at 7.5 vol and realized vol at 6.0. Market positioning keeps risk reversals bid for puts even if spot is up 4% in 2 weeks.
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 have traded lower in EUR and CEE3 over the last week after peaking two week ago when EURUSD 1 month traded as high as 12.60. 1 month is now back to 8.50 compared to 7.50 before Russia invaded Ukraine.
Market have started to turn focus back to inflation and rates and we have seen US rates and the USD trade higher with the last push higher yesterday after hawkish comments from Powell.
USDJPY continues to trade higher with US rates higher and spot has taken out the 120.00 level, spot now trades at the highest level since the start of 2016. Hearing from the street, the 120.00 was a rather large barrier level and now when that is taken out market is short vol to the downside, from vanilla hedges done against the barrier options. At the same time market is long vol at these spot levels and higher. So even if spot has moved up from 115 to 120 in a short time the market positioning makes the risk reversal still trade bid for the downside, 1 month 0.25 for puts, as the market needs to buy back downside strikes while they are long options at current spot levels. This also means that any vol rallies when spot trades higher most likely will be short lived as the market has long options to the topside in the inventory they like to sell. Lastly even if spot is marching higher the realized vol is still trading around 6 vol while implied currently trades at 7.5, giving a risk premium of 1.5 vol which is the highest in G10. With this in mind we prefer to run short vol strategies like covered calls or risk reversals where we buy calls and sell puts to take advantage of the risk reversal that is bid for puts.
Sell 1 week 121.50 USDJPY (covered) call
Receive 20 pips
Buy 1 month 121.25 USDJPY call in 1 mio
Sell 1 month 118.75 USDJPY put in 2 mio
Spot ref.: 120.65We like to play the covered call strategy by selling shorter dated options so we can re-sell and adjust the strike after each expiry. We prefer to do the risk reversal in one by two ratio to take advantage of both the high vol and the risk reversal
- 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 - Webinars
Latest Market Insights
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.