The Low Risk Unlimited Upside

The FX option market is suggesting that the crowd is fully positioned for continued strength in the Yen. Big money is made by betting against crowded trades.

The structure of the FX options market suggests that betting on continued strength on the JPY is a very crowded trade. Furthermore, it also suggests that the best way in which to apply a bearish view on the JPY (bullish view on the USD/JPY, AUD/JPY etc) is via options.

Risk reversals sound complex but they are quite straight forward. The term simply refers to the difference between premiums paid for puts and calls. This difference is entirely a function of the demand for puts vs. calls. The higher the demand for puts the higher will be the premiums charged by option writers. This difference tells you a lot about how the market is positioned - higher the risk reversal the more crowded the trade.

With respect to the JPY it is quoted USD/JPY, EUR/JPY, NZD/JPY etc. So a negative risk reversal means that there is a high demand for puts vs calls which suggests the crowd is positioned for JPY strength. You can see this in the table below. Take note of the AUDJPY risk reversal on line 12. In essence at -7.00 it means that if implied volatility for OTM put options with 6 months to expiry was quoted at say 17% then you could buy OTM calls (equally OTM as the puts) with implied volatility of 10%.




Not only does this differential tell us that the crowd is heavily biased towards the AUD/JPY and other currencies going down against the Yen but rather you would be crazy not to buy calls on these currencies if you were to position yourself for Yen depreciation. Why? Because calls are very cheap. It is almost like you are getting a "free" option to take an aggressive bet against material depreciation in the JPY over the coming weeks/months.

It is not a case of being right or wrong in this game but rather how much money you make if you are right vs. how much you lose if you are wrong. When buying options your risk is defined and your upside is undefined. The cheaper the option the more leverage you can employ.