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:
- Enter 3M ratioed USD/JPY put spread:
buy 3M 114.00 USD/JPY put and sell 3M 112.50 put at double notional
Looking at our FX spot monitor, we observe some very stretched signals in the Scandi FX crosses after the recent strengthening of NOK and SEK. In particular, the NOK is very overbought versus both USD and EUR according to our short term financial model, which historically has been a reliable leading indicator for short-term corrections. Among major crosses, USD/JPY is back in neutral territory after rallying in recent days. In the EM sphere, EUR/TRY remains overbought while the sell-off in EUR/PLN is also stretched relative to short-term valuations.
Implied FX volatility continues to decline across the board and at all maturities, and implied volatility generally looks cheap according to our Volatility Valuation Model. In the 1M tenor, USD/NOK, EUR/USD, AUD/USD and NZD/USD implied is outright cheap according to our model. In longer dated maturities, implied volatility in the above mentioned crosses and the rest of the Scandi FX sphere also looks cheap (neutral valuation but borderline cheap).
Despite stretched EUR/NOK and /USD/NOK spot signals and low implied volatility, we see little value in buying short term upside potential in both crosses via options from a risk/reward perspective, as we see little prospect of a break above 9.00 in EUR/NOK near term.
In terms of volatility selling, our model suggests that USD/JPY is the best candidate with the 3M tenor being outright expensive. Fundamentally, we still expect the JPY to continue suffering in an environment with rising global bond yields and a higher oil price. However, following the rally of recent days and not least given that we still expect USD/JPY to remain in the range of 112.50-118 in the coming months, we recommend exploiting the high implied volatility by buying a 3M 114 USD/JPY put and selling a 3M 112.50 put at a double notional. This structure pays an initial up-front premium of 95 pips (indicative prices, spot ref.: 115.00) and has a maximum profit potential of 245 pips at maturity with spot at 112.50 which is this year's low and was rejected on 17 and 24 January. The structure is profitable as long as USD/JPY trades above 110.05, where the client effectively is long USD/JPY (1x notional) at maturity.
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