Forex Investment and Currency Trading

The massive spot market moves in October have given a further boost to implied vol in the FX options market. Natural sellers of volatility have largely been absent (or, indeed, have been unwinding positions) whilst trading spreads have widened sharply. Amidst the powerful risk aversion and de-leveraging dynamic, risk reversals have stretched out, favouring USD-EM calls over puts. In the majors, implied vols for the “risk appetite” crosses such as AUD-JPY reached exceptional levels (90% implied in the 1-week) whilst risk reversals have favoured USD-JPY puts. In general, the implied vol surface has become more inverted amidst the market turmoil, with short-term vols climbing most steeply. Superficially this makes selling short expiry options most lucrative, but there are risks the
credit crunch (and associated USD strength) may not be over whilst day-to-day market volatility remains high. The best opportunities are in longer-dated expiries, particularly for “managed” FX crosses, which may stabilise and even drift lower over the latter half of 2009.

Sell 1Y USD call / CNY put

• Sell a 1Y 7.50 USD call / CNY put
• Spot reference: 6.8360
• Vol reference: 13.25%
• Premium received: USD 3.3% notional

The premium from selling 1-year USD-CNY calls has been boosted by the rotation higher in USD-CNY forwards (now 1.1% above spot), a jump in 1-year implieds and a risk reversal favouring USD calls.

Sell 1Y USD call / INR NDF (offshore) put

• Sell a 1Y 52.50 USD call / INR put NDF (offshore) put
• Spot reference: 47.70
• Vol reference: 20%
• Premium received: USD 5.8% notional

USD-INR volatility has remained relatively subdued amidst Reserve Bank of India intervention (three-month realised is just 7.3%), but off-shore implied vol has surged amidst market dislocation across the expiries out to 1-year. The strategy can be made more defensive by buying short-expiry protection; a two-month 52.50 call (over year-end) costs 1.7%.