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.
Long EUR/SEK via 1M EUR/SEK 1:2 ratioed call spread.
Long EUR/GBP via 1M bullish 2:1:1 ratioed seagull.
Looking at our FX spot monitor, we currently observe the biggest misalignments in the Scandi FX crosses, with both NOK and SEK appearing relatively expensive versus EUR and USD according to our short-term financial models. In particular, EUR/SEK is very oversold, trading 2.5 standard deviations below our short-term model's fair value estimate of 9.6491. Historically, the model-spot deviation for EUR/SEK has been a reliable leading indicator for corrections and we recommend positioning for a possible spike higher in EUR/SEK via a 1M ratioed call spread. We enter the structure by buying 1M call strike 9.4550 (spot) and selling 1M call strike 9.6000 at the double amount. The structure costs a premium of 360 pips (indicative prices) and is profitable if EUR/SEK trades within the range of 9.4910-9.7090 at maturity. We prefer to reduce the short vega position by paying a premium, as implied 1M volatility is neutral, according to our volatility valuation model, while still benefiting from the expensive risk reversal.
Fundamentally, we remain bearish on EUR/SEK and tactically we still look to sell on rallies. Indeed, the SEK could see further support if the Riksbank reduces its easing bias at its meeting on 15 February. However, we still think the cross has come a long way quickly and, thus, from a risk/reward perspective, we like to position for a temporary bounce.
Among the majors, EUR/GBP also looks increasingly oversold. We still expect the GBP increasingly to come under pressure, as the triggering of the article 50 raises policy uncertainty, and we recommend positioning for a move higher in EUR/GBP via 1M ratioed bullish seagull. Selling the wings in EUR/GBP is relatively attractive given the expensive butterfly (see page 22). As we see little prospect of a significant decline in EUR/GBP in the short term, we prefer to sell the double put to finance greater profit potential on the upside. Beyond the 1M tenor, as the French presidential election moves closer, the risk to EUR/GBP could be more two sided in the case of a rising EUR risk premium. Hence, we prefer to position for a higher EUR/GBP within the 1M tenor. We enter the structure at zero cost by buying 1M call strike 0.8520 (spot), selling 1M call strike 0.8700 and 1M put strike 0.8400 at double notional.
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