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.
- Long NOK/SEK via 1M bullish risk reversal.
Implied volatility before and after the French presidential election has traded lower over the past three weeks and implied volatility up to the one-month tenor generally trades in 'cheapish' territory, with 1M USD/NOK and 1M NZD/USD being outright cheap according to our FX volatility monitor.The market's pricing of the event risk on 8 May has been relatively stable, with one-day implied forward volatility trading around 37.5% in EUR/USD and close to 60% in EUR/JPY (when adjusting for the weekend).Comparing pricing of the event risk with price action seen on the day after the UK's EU referendum (24 June 2016), EUR/JPY volatility in particular still looks cheap as the breakeven range of a one-day delta neutral straddle covers less than 50% of the decline seen in EUR/JPY on 24 June. Hence, clients looking to buy tail risk protection related to the French election should probably consider buying EUR/JPY put spreads, which benefit from the extreme negative risk reversal.
In the Scandies, USD/SEK and NOK/SEK is significantly overbought according to our short-term financial model, while the model can explain most part of the recent move higher in EUR/NOK and USD/NOK, which has been mainly oil driven. Fundamentally, we are bullish on both NOK and SEK and following the recent oil price decline, we see more potential in NOK relative to SEK in the medium term. However, in the near term, NOK remains in the hands of the oil price and, tactically, we prefer a cautious stance on NOK ahead of the Fed. However, in Scandi Markets Ahead: Norges Bank meeting and focus on 'weak' NOK (12 March), we argue that NOK positioning is no longer stretched and is now almost neutral. Moreover, we note that 1M NOK/SEK 25 delta risk reversal has fallen substantially and is borderline cheap, according to our 'skew monitor'. Hence, from a risk/reward perspective, we see value in pursuing a correction higher in NOK/SEK via 1M bullish risk reversal. We enter the strategy at zero cost by buying 1M NOK/SEK call with strike at 1.0625 and selling 1M put strike 1.0360 (indicative prices, spot ref.: 1.0485).
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