FX Quant Strategy provides a quantitative overview of the currency market, including several valuation tools and monitors, focusing on the FX options market.
This week we recommend two FX option trades:
Buy USD/NOK call spread with expiry at 11 May 2016
Enter bullish 3M USD/JPY risk reversal
Implied FX volatilities have in general been trading sideways following the sharp decline in March. In the majors, 2W implied volatility in EUR/JPY and USD/JPY has become elevated due to the upcoming Bank of Japan meeting. Also at-the-money (ATM) GBP volatility for maturities at 3M and beyond stick out as 'expensive' due to the 'Brexit' risk.
In the Scandi-sphere, ATM volatility at the 0-1M tenors is trading in borderline cheap territory according to our volatility valuation model. We think especially USD/NOK, USD/SEK and NOK/SEK are buying opportunities. According to our spot valuation model, USD/NOK looks oversold, and we recommend buying USD/NOK call spread with expiry on 11 May 2016 in order to position for a likely bounce going into the Norges Bank meeting on 12 May.
In terms of option skews, we currently observe the most stretched valuations in sterling-crosses, with GBP put options being extremely expensive relative to similar call options. The extreme options skews are of course due to the Brexit risk, and given the very high digital risk attached to the UK's EU referendum on 23 June we prefer to stay sidelined in GBP from a speculative point of view.
USD/JPY risk reversals look cheap from 1M and beyond following the recent decline in USD/JPY spot. As argued in FX Strategy: BoJ set to stabilise USD/JPY (12 April) we think the very negative USD/JPY risk reversal, from a risk/reward perspective, offers good value, and we like to be long 3M risk reversal going into the BoJ meeting on 28 April as we expect the BoJ to cut interest rates by 20bp to -0.3%. As such, the impact on USD/JPY from a rate cut further into the negative may be relatively limited given the underlying fundamental JPY support. However, stretched short-term FX drivers such as positioning and technical indicators imply BoJ easing might be able to counter the strong downward pressure on USD/JPY stemming from fundamentals. We target USD/JPY at 1.12 in 1M.
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