Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
OTC Derivatives Trading
Summary: USDJPY has rallied over the last days and taken out several important resistance levels on the way. Vols trades bid with front end vols trading close to the highest level in a year. 1 month risk reversal has flipped over to trade favor USD calls, this has only happened a few times over the last 5 years. We like to play any long USDJPY positions through ratio call spreads or alternative Reverse-Knock-Out option to take advantage of the spike in vol and the positive risk reversal.
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.
We have seen a strong rally in USDJPY spot since beginning of the year as US rates have traded higher. USDJPY spot is up from 103 at the start of the year and has now started to move higher again after consolidating around 110 for a couple of months when US rates trade a bit lower. US rates have started to move higher again and USDJPY spot has traded out of the long term trend channel and taken out the resistance at 112.25. Spot is now moving higher with turbo speed and closing in on 114.25-75 resistance area on the topside.
Vols are marked higher with 1 month currently trading at 6.75, 93rd percentile looking at 1 year historical data, compared to 5.7 on Friday. 1 month risk reversal has flipped over and trades favoring USD calls, currently 0.1 for USD calls which is the 100th percentile looking at 1 year historical data. 1 month risk reversal has only traded favor for USD calls a few times over the last 5 years.
Think we might run in to some long gamma from barriers at 115 but don’t know if that will be enough to halt the spot for long. We could see a sharp drop in vol if spot starts to slow down when closing in on 115, which would benefit any short vol strategies.
We like to play any long USDJPY positions with low-cost strategies like ratio call spreads or alternative Reverse Knock Out calls considering the rally in spot over the last days. Both strategies take advantage of the high vol and the positive risk reversal in the front end.
Buy 1 month 114.00 USDJPY call in 1 mio
Sell 1 month 116.00 USDJPY call in 1.5 mio
Cost 47 pips
The 114.00 call cost 73 pips on its own
Alternative
Buy 1 month 114.00 USDJPY call with Knock-Out at 116.00
Cost 22 pips
Or if you put the barrier at 117.00, cost would be 35 pips.
Spot ref. 113.65
The knock-out option will cease to exist if spot trades at the knock-out level at any time before expiry.
Note the Knock-Out options are not available on the platform and can only be traded off-line. Contact your sales representative to see if the product is available for trading in your country.
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