technical analysis

FXO Market Update - Oct 8

Mathias-Alrixon-400x400
Mathias Alrixon

OTC Derivatives Trading

Summary:  Event risk for the US election day has decreased over the last weeks while we still see interest to buy a bit longer dated options to cover for any delay in the election result. AUDJPY has a high correlation to the equity market and offer a cost-efficient way to hade for tail risk. We take a look at the vol pricing of the event and alternative ways to hedge long equity portfolios over the event.


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.

 

It is less than 1 month left to the US election and we have seen the risk premium for the event decrease over the last weeks to now trade at the lowest level since beginning of August. Some of the risk premium has been priced out of the market but most has moved further out on the curve as the market does not expect a firm result on 4th Nov due to the post voting. At the moment the market prefers to own the week after the election, or longer dates, over owning 4th of November. Popular dates to own have been 9 Nov, Monday after the election, or dates around 8 Dec which is the date states have until to resolve disputes over the result, including recounts.

Below table shows the current O/N Forward vol for the election day as of today and how it was priced on 3 Aug. The other column shows the corresponding implied move for the event, calculated as the cost of an O/N straddle.

08_MAAL_1
Source Saxo Bank. O/N Vol column: O/N forward vol for 3-4 Nov, Implied 1 day move column: Cost of O/N straddle

USDMXN is the only currency pair which has a higher event vol now compared to back in August, this is partly due to the higher vol in general in MXN. USDMXN curve is currently trading 6-7 vol higher than in August.

The outcome of the 2016 election caused some exceptional volatility with big moves on the election night. Below table compare current expected ranges for this year’s election with the Hi/Lo and Open/Close ranges for the 2016 election day.

08_MAAL_2
Source: Saxo Bank. Implied 1 day move: Cost of O/N straddle. Hi/Lo range: High/Low daily range for 2016 election. Open/Close range: Open/Close daily range for 2016 election
 

We had some very high volatility during the 2016 election night with very wide High/Low ranges but when the smoke cleared the Open/Close ranges came in more in line with how the marked had priced the event.

It is advisable to hedge your exposure before a big event like the election. Hedging with linear products could be costly with big swings in the underlying and it will limit to upside potential if the underlying would move higher. Hedging with options gives a higher degree of freedom for the investor and has the potential to fully participate if the market would move in a favorable direction.

Hedging equity exposures direct with equity options is of course the most efficient way but the high volatility makes buying options expensive. AUDJPY has a high correlation, ~70%, to the S&P and offer a low-cost alternative to hedge against tail risk in risk assets. Below we will look at two alternatives to hedge against a lower equity market after the election, a direct hedge in S&P or a more cost-efficient alternative using AUDJPY options as a hedge.

08_MAAL_3
Source: Bloomberg

We have looked at 3% out of the money puts in S&P and AUDJPY with expiry 18 Dec. 3% OTM strike gives a good hedge compared to an at the money strike with significant reduced premium and 18 Dec expiry covers any eventual delay in the result. For a cheaper hedge buy a further out of the money strike or a shorter expiry. We would not choose too short expiry as we want to capture any delay in the result as well as any short-term trend in the market following the election result.

Buy 18 Dec AUDJPY 73.65 put (3% OTM)
Cost 85 pips/1.13%, vol 13.30

Buy Dec S&P 3315 put (3% OTM)
Cost 125.90 pips/3.68%, vol 27.80

Spot ref. 75.90 and 3419.50

S&P trades with a beta of 1.8 against AUDJPY, seen over the last year. This means we can expect to see 1.8 times larger moves in S&P than in AUDJPY. If S&P moves with 10%, AUDJPY is expected to move with 5.55%.

If you want to hedge a 1 mio USD exposure in S&P you then have to buy 1.8 mio USD equivalent of AUDJPY put. I.e. beta adjusted the AUDJPY option cost 2.03% (1.13*1.8) hedging the S&P exposure compared to hedging direct in S&P which would cost 3.68%.

If we compare the two options above and look at the pay-out for a move 10% lower in S&P, which would be equivalent to 5.55% move lower in AUDJPY. The S&P option would make 7.0% or 1.90 times the premium. The AUDJPY option, beta adjusted, would make 4.59% or 2.26 times the premium.

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

Forex Options - Webinars

Quarterly Outlook

01 /

  • Upending the global order at blinding speed

    Quarterly Outlook

    Upending the global order at blinding speed

    John J. Hardy

    Global Head of Macro Strategy

    We are witnessing a once-in-a-lifetime shredding of the global order. As the new order takes shape, ...
  • Equity outlook: The high cost of global fragmentation for US portfolios

    Quarterly Outlook

    Equity outlook: The high cost of global fragmentation for US portfolios

    Charu Chanana

    Chief Investment Strategist

  • Asset allocation outlook: From Magnificent 7 to Magnificent 2,645—diversification matters, now more than ever

    Quarterly Outlook

    Asset allocation outlook: From Magnificent 7 to Magnificent 2,645—diversification matters, now more than ever

    Jacob Falkencrone

    Global Head of Investment Strategy

  • Commodity Outlook: Commodities rally despite global uncertainty

    Quarterly Outlook

    Commodity Outlook: Commodities rally despite global uncertainty

    Ole Hansen

    Head of Commodity Strategy

  • Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?

    Quarterly Outlook

    Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?

    John J. Hardy

    Global Head of Macro Strategy

  • Equity Outlook: The ride just got rougher

    Quarterly Outlook

    Equity Outlook: The ride just got rougher

    Charu Chanana

    Chief Investment Strategist

  • China Outlook: The choice between retaliation or de-escalation

    Quarterly Outlook

    China Outlook: The choice between retaliation or de-escalation

    Charu Chanana

    Chief Investment Strategist

  • Commodity Outlook: A bumpy road ahead calls for diversification

    Quarterly Outlook

    Commodity Outlook: A bumpy road ahead calls for diversification

    Ole Hansen

    Head of Commodity Strategy

  • FX outlook: Tariffs drive USD strength, until...?

    Quarterly Outlook

    FX outlook: Tariffs drive USD strength, until...?

    John J. Hardy

    Global Head of Macro Strategy

  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

Content disclaimer

None of the information provided on this website constitutes an offer, solicitation, or endorsement to buy or sell any financial instrument, nor is it financial, investment, or trading advice. Saxo Bank A/S and its entities within the Saxo Bank Group provide execution-only services, with all trades and investments based on self-directed decisions. Analysis, research, and educational content is for informational purposes only and should not be considered advice nor a recommendation.

Saxo’s content may reflect the personal views of the author, which are subject to change without notice. Mentions of specific financial products are for illustrative purposes only and may serve to clarify financial literacy topics. Content classified as investment research is marketing material and does not meet legal requirements for independent research.

Before making any investment decisions, you should assess your own financial situation, needs, and objectives, and consider seeking independent professional advice. Saxo does not guarantee the accuracy or completeness of any information provided and assumes no liability for any errors, omissions, losses, or damages resulting from the use of this information.

Please refer to our full disclaimer and notification on non-independent investment research for more details.

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

All trading and investing comes with risk, including but not limited to the potential to lose your entire invested amount.

Information on our international website (as selected from the globe drop-down) can be accessed worldwide and relates to Saxo Bank A/S as the parent company of the Saxo Bank Group. Any mention of the Saxo Bank Group refers to the overall organisation, including subsidiaries and branches under Saxo Bank A/S. Client agreements are made with the relevant Saxo entity based on your country of residence and are governed by the applicable laws of that entity's jurisdiction.

Apple and the Apple logo are trademarks of Apple Inc., registered in the US and other countries. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.