OTC Derivatives Trading
Summary: Vols continue to trade bid with yields and the dollar on the move. We have seen vol trade higher in most currency pairs over the last week and the move in vol is greater than what the increased spot moves represent. This has led to all currency pairs except EURNOK now trades with risk premium to realized vol, where JPY vols are the most expensive in G10 and RUB the most expensive in EM.
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.
Volatility trades bid as yields are on the move and USD trades stronger. The market trades a bit nervous and we see good demand of buying options across many currency pairs. The nervousness and demand of buying options can be seen in the risk premium, see top and bottom left graphs below. Only EURNOK trades with a discount against the realized volatility while the rest of G10 and EM trades with a positive risk premium. JPY vols are the most expensive in the G10 space while RUB vols are the most expensive in the EM space.
Risk reversals are moving more towards USD calls with EURUSD 1 month risk reversals trading 0.35 for EURUSD puts, the highest levels for puts since June last year. We prefer to sell vol here and especially EURUSD puts with the high risk reversal and high risk premium. Either sell puts, outright or as covered put depending on your view or buy ratio put spread.
JPY vols are the most expensive when looking at the risk premium. USDJPY spot has accelerated higher over the last week and implied vol has taken another leg higher. The move in vol is greater than what the spot move represent, keeping the vol as one of the most expensive. Risk reversal trades close to flat in 1 month giving neither side no additional extra value. The risk reversal rarely trades for USDJPY calls which makes this a rare opportunity to sell USDJPY calls without any major discount.
GBPJPY vol is the most expensive in G10 and we have seen spot trending higher since the beginning of the year. GBPJPY risk reversal trades favor for downside with 1 month currently trading at 1 vol for GBPJPY puts. If you think the trend higher will continue, sell GBP puts to collect premium or buy the risk reversal. A variation could be to buy 1 mio of GBPJPY call with strike at spot and sell 2 mio of a GBPJPY put with strike 200 pips below spot. This structure would be close to zero cost in the 1 month.
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.
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