Forex Investment and Currency Trading

• On the back of extreme risk aversion and continued tension in global money markets, USD/JPY has recently traded to a low of 91, a level not seen in 13 years. 
• Deleveraging and continued unwinding of the carry trade remain major driving forces in FX, keeping USDJPY close to historic lows.
• However, aggressive global government intervention will eventually bring some degree of normalcy to money markets and a slowing economy.
• Despite the passing of the Emergency Economic Stabilization Act and a coordinated European government rescue plan, the markets are still weary of risk. USDJPY, a risk Proxy, continues to trade at attractive levels for investors with long JPY exposures.
• Recommended Hedge Strategy - benefits from current option market dynamics in addition to attractive spot and forward point levels.
• The Forecasts for USD/JPY are at 112, 108 and 114 in 3, 6 and 12 months. Economic pessimism continues in Japan:

                    — Consumer sentiment is again down. 

                   — If the yen were to remain around its present level of under ¥100/US$,   
                      corporate earnings would suffer from further risk of being downgraded, chiefly 
                     exporters.

• The BoJ did not participate in the coordinated global rate cut on October 8. It’s expected the BoJ to cut rates by 25bp during Q4 2008 and stay on hold at 0.25% during 2009. 
• While rising volatility has led to some slowing in carry outflows, they do remain quite strong. Given the extreme risk aversion globally, it is important to look for any evidence that Japanese investors are starting to bring capital back to Japan. This action could push the Yen substantially stronger even from current levels.

Hedging Strategy - Zero Cost Collar

• Buy a USD Call/ JPY Put and sell a USD Put / JPY Call for zero cost
• Tenor - 1 year
• Spot Reference - 92.50
• Strike Purchased Call - 100.00
• Strike Sold Put - 61.00
• Forward Reference - 90.50
• Net Cost - Zero Cost

Trade Description

• The historically high volatility skew (favoring USD/JPY Puts over USD/JPY calls) lends itself to participation in the options market through a zero-cost collar, enabling more upside in JPY strength / USD weakness.
• Purchases a USD/JPY Call and sells the higher Vol USD/JPY Put for zero cost. 
• The structure provides protection against JPY weakness past the strike of the bought USD/JPY Call at 100 and allows for participation in favorable currency moves all the way down to the strike of the sold USD/JPY Put at 61.