Forex Investment and Currency Trading

The powerful upswing in FX vols, which characterized 2008 has given way to a more mixed picture in early 2009. Most strikingly, the bell-weather “risk appetite” crosses, such as AUD-JPY, are posting realized vols well below the October 2008 peaks. Where day-to-day gamma is still high by historical standards, many of the abrupt moves are subsequently mean–reverting rather than seeing new, powerful trends. However, the picture remains mixed. Pockets of localized FX weakness (such as MXN and the Emerging European currencies) still have potential to drive vols back close to late-2008 highs. Understanding these cross-currents is key to successful option positioning.

The liquidation and deleveraging of “high yield” carry trades may be almost complete – a conclusion suggested by the price action and positioning. Out-size market volatility associated with USD funding shortages (such as in KRW) may also be ebbing. However, the economic dislocations and impact of the credit crunch on the global economy are still being felt. Asian countries heavily exposed to the global trade contraction may still see higher FX implied vols over time as the delayed impact of the financial crisis has a slow-moving, but powerful impact on domestic economic activity. Upside surprises in USD-TWD, for example, may be yet to come whilst currencies which performed powerfully in the initial deleveraging phase (notably JPY) may be more stable amidst the macroeconomic turbulence.

Sell 3mth USD call / KRW put

• Sell a 3M ATMF USD call/KRW put, strike 1380
• Spot ref: 1380 on USD-KRW
• Receive USD 3.9% USD notional

Neutral recommendation is put on the Korean won (KRW) and one suspects the peak of USD-funding related volatility may be behind us. Implied volatilities have been relatively “sticky” higher at high levels (28% at three month) even as spot has range-traded.

Sell 6mth USD put / TWD call

• Sell a 6M ATMF USD put/TWD call, strike 33.50
• Spot ref: 33.67 on USD-TWD
• Receive USD 2.5% USD notional

USD-TWD has substantial upside potential as the domestic economy takes a hit from a powerful slump in exports. The central bank keeps close control of spot, containing realized (and implied) volatilities but has also signalled a clear preference for a higher USD-TWD.