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 one FX option trade: buy 6M 1.0800-1.1290 EUR/USD put spread.
Implied volatility has in general stabilised after last week's bounce higher. While FX volatility has increased, levels are still low - and in particular, EUR/USD and USD/SEK implied volatilities are cheap according to our FX volatility valuation monitor. In FX Strategy: EUR/USD and USD/SEK implied volatility still cheap despite recent uptick, 24 May, we highlight that our quantitative business-cycle model has turned increasingly negative and we see improved risk-reward for selective long vega strategies, as FX option volatility usually becomes more volatile with a tendency to spike when the business cycle turns. We find that (1) clients considering hedging USD assets should buy 2Y EUR/USD call option and (2) clients considering hedging global equities should buy USD/SEK call option.
Looking at the signals from our FX spot monitor, EUR/USD looks increasingly overbought trading 1.2 standard deviation above our short-term financial model's fair value estimate of 1.0966. As argued in FX Strategy: EUR/USD: gravitational pull kicks in - but pause ahead, 24 May, we look for EUR/USD to trade within the 1.08-1.14 range in coming months and recommend looking for opportunities to sell the pair for a near-term correction lower. A key catalyst for EUR/USD downside could be a weak eurozone CPI print for May. In the FX option space, we recommend positioning for a possible correction lower in EUR/USD by buying 6M 1.1290 - 1.0800 put spread. This strategy costs an initial upfront premium of 165 pips (indicative prices, spot ref.: 1.1180) and is profitable if EUR/USD trades below 1.1125 at maturity. The strategy would benefit from an increase in implied volatility, which - as mentioned above - is currently cheap.
In the Scandi FX sphere, we currently observe no strong spot signals. While we remain bullish NOK and SEK longer term, we maintain a strategically cautious stance in the near term, as we do not see any imminent triggers for a sustained move lower in EUR/SEK or EUR/NOK. Moreover, we stress that with implied volatility trading in 'cheap-ish' territory, we do not find volatility selling strategies in EUR/NOK and EUR/SEK attractive from a risk/reward perspective.
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