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:
- Enter bearish 3M EUR/NOK risk reversal for a premium
- Buy 3M EUR/SEK ATM (at-the-money) put
Implied FX volatility has fallen sharply over the past month post the UK EU referendum and volatility on maturities up to the three-month tenor is generally cheap or borderline cheap across most currency pairs. For longer maturities, our models suggest that the 12M tenors are generally more neutrally priced at the moment. Among the majors, especially 1M and 3M EUR/USD volatilities are cheap while USD/SEK volatility strands out in the ScandiFX sphere with maturities up to the 3M tenor being cheap, according to our valuation model.
Looking at the signals from our spot monitor, we find that both EUR/SEK and EUR/NOK stand out as looking currently expensive. In particular, EUR/SEKis oversold trading 1.6 standard deviations above the model's short-term fair value estimate of 9.4739. Fundamentally, we think that valuations and growth are supportive for the SEK medium term, and we are short EUR/SEK in our FX trading portfolio targeting 9.20 (see Danske Bank FX Trading Portfolio: Sell EUR/SEK , 29 July 2016, for details). In the EUR/SEK trade recommendation, we suggested to alternatively position for a lower EUR/SEK via a 3M bearish risk reversal. However, since we entered the spot trade in the FX trading portfolio, 3M EUR/SEK 25 delta risk reversal has traded lower, and we now favourbuying a 3M at-the-money put option to position for a correction lower in EUR/SEK as implied volatility offers an attractive risk/reward, in our view.
We recommend to express our model's bearish EUR/NOKview via a bearish 3M EUR/NOK risk reversal. We recommend lifting the bought put strike to ATM against a premium as this strategy utilisescheap volatility and the positive option skew (which is expensive according to our skew monitor). Specifically, we recommend buying a 3M EUR/NOK put option with strike at 9.4550 and selling a 3M call option with strike at 9.6000. This strategy costs an initial up-front premium of 500 NOK pips and is profitable if EUR/NOK trades below 9.4050 at expiry on 2 November 2016.
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