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 6M EUR/NOK skewed risk reversal
Enter bullish1M USD/JPY risk reversal
Implied FX volatilities have edged higher over recent weeks amidst the turmoil in the financial markets. According to our FX volatility valuation model, AUD/NZD options are expensive across the curve, while longer-dated options in EUR/NOK, EUR/SEK and NOK/SEK also trade in expensive territory.
The price of USD call options has in general declined substantially relative to put options over the past couple of months and 25 delta risk reversals in almost all USD-crosses trade at stretched levels according to our skew monitor. Hence, both EUR/USD, GBP/USD risk reversals are expensive according to our models although the risk reversals remain outright negative. Similarly, USD/NOK and USD/SEK option skews are historically cheap although the outright levels are positive. We find one exception, namely USD/JPY, where both 2W and 1M risk reversals are cheap and negative. While spot currently trades in neutral territory according to our short-term financial models, we are fundamentally bullish USD/JPY and would like to increase exposure in USD/JPY at levels below 120. We recommend entering 1M bullish USD/JPY risk reversal.
According to our spot monitor, NOK is significantly undervalued vis-à-vis EUR and SEK and while we remain slightly bearish on the NOK in the short term - due to oil price uncertainty and a likely rate cut from Norges Bank on 24 September - we maintain our stance that the NOK is cheap from a fundamental point of view. We think the combination of stretched spot valuation and attractive volatility and skew valuations offer a good opportunity to build up short EUR/NOK positions for long term investors. We recommend selling 6M EUR/NOK 1:2 ratioed risk reversal.
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