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 GBP/USD risk reversal.
Long 2W USD/SEK call spread.
Implied FX volatility with maturities up to 3M mostly trade in neutral territory, with shorter dated options in particular looking relatively cheap according to our models. At the 6M and 12M tenors, both EUR/NOK and NOK/SEK volatility are still expensive, reflecting an increased risk premium on NOK.
According to our FX short-term financial models, we currently observe the biggest misalignment in USD/SEK, which trades 2.3 standard deviations below the fair value estimate of 8.819 (spot. ref.: 8.529). We recommend positioning for a possible bounce in USD/SEK by buying 2W 8.55/8.70 call spread and thereby utilising the relatively low implied volatility. Options expire on 3 September - the same day as the next Riksbank meeting.
When adjusting for implied volatility, 25 delta risk reversals for EUR/USD and GPB/USD continue to trade in expensive territory - albeit both skews are negative on absolute levels. Moreover, both pairs are significantly overvalued according to our short-term models and we are already short both EUR/USD and GBP/USD outright in our FX Trading Portfolio. As argued in FX Strategy: EUR/GBP - near-term support as low inflation postpones BoE hike (14 August), we think a short GBP/USD offers an attractive risk/reward as the cross should react asymmetrically to the Fed. Hence, in the FX options space, we recommend positioning for a possible renewed rally in USD via 3M bearish GBP/USD risk reversal benefiting from stretched spot and skew valuations.
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