FXO Market Update - May 25

USD trades lower as inflation fears fade again and the dollar index closing in on the year-to-date lows. CNH spot trades stronger with US 10y down below 1.60 and CSI300 up over 3% today. USDCNH spot has traded down below the 6.4000 level for the first time since 2018 and the market is ready for a move lower, low from 2018 was 6.2360.

USDCNH vols are sharply higher today with 1 week up almost 1 vol and 1 month up 0.4. The risk reversal has flipped over to trade favor the downside in the frontend, 1 month risk reversal now trades 0.15 for USDCNH puts compared to 0.2 for calls yesterday.

Even if vols are higher over the last days we still trade below year-to-date average and we see vols to initially trade higher if spot can stay below 6.4000. We think put spreads or time spread where you for example buy 1 month and finance it by selling 1 week offer good value for lower USDCNH trades and both strategies take advantage of the last days move in vol and skew.

Buy 1 month 6.3900 USDCNH put
Sell 1 month 6.3400 USDCNH put
Cost 155 pips (6.3900 put cost 254 pips)

Alternative

Buy 1 month 6.3900 USDCNH put
Sell 1 week 6.4100 USDCNH call
Sell 1 week 6.3700 USDCNH put
Cost 100 pips

• 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