FXO Market Update - Oct 05

Kiwi rate decision tomorrow and market is expecting a hike of 25bp to 0.5%, market pricing 85% probability for a hike. O/N vol trades at 20 vol which is the highest level in ten meetings, O/N for the meeting was this high at the May 2020 meeting the last time. At that time the whole vol curve was a lot higher due to the peak of the covid crisis. As comparison NZDUSD 1 month traded at 13 vol in May 2020 compared to 9.75 vol today. 20 vol equal to an expected move of 58 pips in spot over the meeting.

We think the O/N is priced on the high side when market pricing 85% probability for a hike and like to sell the front-end of the curve. Either sell O/N outright or buy a bit longer dated options and finance it by selling shorter dated options to take advantage of the steep vol curve, O/N trades at 20 vol while 1 week trades at 10.75 vol.

Sell O/N 0.6920 NZDUSD put
Sell O/N 0.6980 NZDUSD call
Receive 25 pips

Buy 1 week ATM put or call
Finance the bought 1 week by selling O/N 0.6920/0.6980 strangle, strikes 30 pips on each side of the bought option.
The structure would cost around 19 pips compared to 45 pips if just buying the 1 week.

Spot ref. 0.6950

• 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