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:
Sell 1M EUR/GBP at-the-money call as a tactical trade
Enter bearish 3M NOK/SEK 1:2 ratioed risk reversal
Implied FX volatility
has generally traded sideways over the past weeks. Consequently, the 0-1M tenors in the G10 sphere still trade in 'cheapish' territory according to our volatility valuation model. At the 3M tenor, our model valuations suggest that implied volatility is borderline expensive in most NOK, SEK, GBP and JPY crosses. 12M volatility in EUR/GBP, EUR/JPY, GBP/USD and USD/JPY is expensive, while 12M EUR/USD volatility still looks 'cheapish'.
Looking at our FX spot monitor , we currently observe some very stretched signals in the Scandi FX crosses after the recent strengthening of NOK and weakening of the SEK which has sent EUR/NOK into oversold territory and EUR/SEK into overbought territory. The divergent directions for NOK and SEK have pushed NOK/SEK significantly higher, and the cross is currently 'very overbought' according to our short-term financial model, trading 2.4 standard deviations above the model's fair value estimate of 1.0421. We are fundamentally bullish on both NOK and SEK on a medium-term horizon, and in this respect, not least the move higher in EUR/SEK looks like a selling opportunity. However, it is also our view, that EUR/NOK has probably come down too much too fast and we thus recommend positioning for a correction lower in NOK/SEK via a 3M bearish 1:2 ratioed risk reversal. This strategy can be entered at zero cost (spot ref. 1.0705, indicative price) by buying a 3M NOK/SEK put option at strike 1.0500 and selling a 3M call option at strike 1.0900 at a double notional. This position would also benefit from 'borderline expensive' NOK/SEK implied volatility.
In the majors, GBP looks increasingly oversold versus both EUR and USD following the past days' price action where GBP has declined as Brexit has returned as a key theme in FX markets. Technically, the 14 day RSI has risen to 74 and our short-term financial models suggest that the cross currently trades 1.2 standard deviations above the model's fair value estimate of 0.8534. Hence, while we remain bearish on GBP fundamentally and still expect EUR/GBP to trade higher in 6 months, we see a high risk of a correction lower over the coming month. Earlier today, we recommended taking profit on our long EUR/GBP position which we entered on 5 September (see Danske Bank FX Trading Portfolio - Take profit on long EUR/GBP position , 5 October 2016, for details). In the FX option space, we recommend expressing this view by selling 1M EUR/GBP call option, thereby utilising a stretched spot signal and borderline expensive implied volatility.
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