Forex Options Volatility Update mardi, 13. février 2007 11:15:35 GMT

Volatility Update and Option Strategies
Volatility Update and option strategies.

STRATEGIES:  GBPJPY call, EURNOK risk/reversal, EURUSD against USDJPY relative value

GBPJPY

Buy GBPJPY Call, strike 245, expiry 20th Feb 2007 (1 month)

Cost: 26 pips

Spot Ref.: 238.97

Arguments:

Realized volatility in the underlying (GBPJPY) has increased along with implied volatility, however relatively to eachother, realized are higher than implieds which argues for long vol positions. Some market participants play this through long spot and short call betting on a stable trend will decrease vols and hence increase the value of their short vol positions. This howeever is not without risk as you must be willing to take substantial losses in spot as you leave yourself short naked calls if stopping the spot out.
The volatility curve is comparably flat, meaning that especially longer term options are relatively cheap. However we expect implied volatilities to revert to mean soon which indicates higher longer tenors.
BoE hiked rates last week while BoJ kept rates ungchanged in January. This makes carry trades in this cross especially attractive and should keep demand high.
GBPJPY remains in a healthy bull trend, soon testing 1998 highs at 240.90. A break of this resistance level can accelerate the bull trend.
USDJPY (straddle) - closed

Profit: we got exercised on our call at 120.37 and closed it at 121.75. Subtracting the cost of the strategy (106 pips) this leaves us with a 32 pip profit.

Buy USDJPY Call, strike 120.37, expiry 22nd Jan 2007

Buy USDJPY Put, strike 120.37, expiry 22nd Jan 2007

Entry range: 120.30 - 120.80


EURNOK (risk/reversal)

Buy EURNOK Put, strike 8.18, expiry 14th March 2007

Sell EURNOK Call, strike 8.49, expiry 14th March 2007

Entry range: 8.31 - 8.34

Arguments:

NOK has not been rewarded for the recent positive data (higher retail sales, unemployment falling) and we feel this is a misjudgement by the market. The oil sell-off seem to be one of the drivers of the rally in EURNOK - oil seems stabilized around 53-55$ bbl.
EURNOK has been correcting higher, but has been capped below 61% retracement (from 8.4950-8.0877), which leaves the bearish bias intact on a weekly outlook. Only a close above 8.5000 would change the longer term bearish technical picture. Has not traded above.
The 25d R/R is 0.2C which provides an opportunity to place the "moeny-making" put strike closer to market than "money-loosing" call. Also the 0.2C is a relative high level compared to level looking back 1 year - in other words. The current pricing of Calls (which we are short) should fall and benefit Puts (which we are long).

1 "relative value" active (EURUSD against USDJPY)

CURRENT PnL in pips: EUR call -29 pips, USDJPY put +89 pips

CURRENT PnL in USD (if the investor trades 1 mio a leg): EURUSD leg -2900 $ and USDJPY leg +7500 $ gives a total of 4600 $ with very limited risk.

Buy EURUSD Call, strike 1.3550, 3 months (2nd March 2007)   
against   

Sell USDJPY Put, strike 112,90, 3 months (2nd march 2007)   
Cost: Zero
Spot ref.: EURUSD 1,3190
Spot ref.: USDJPY 116,25   
Arguments:

Outperformance of EUR against JPY vs USD. Means the investor is making money if EURUSD moves more relative to USDJPY. Evidence of this current correlation of EURUSD faster mover than USDJPY could be seen in during the past 2 weeks movements.
Vol smile in USDJPY traditionally favors a higher price in Puts due to Japanese corporate flow. This means when doing a zero-cost one get the strike of USDJPY further away from the market in percentage then is the case with EURUSD strike. So if EURUSD at the same time continues to outperform USDJPY then the EURUSD Call should get faster and further in-the-money than is the case with USDJPY.
Basically ... if USD moves higher then you will lose premium paid on the EUR Call but make the same on the USDJPY Put. That nets out as an "Even-Steven" deal ... ;-))
Risk to the investor is if USDJPY starts moving more (relatively) than EURUSD ... thereby changing the current environment of USDJPY underperformance against EURUSD.
The EURUSD Call is 2,70% away from the market and the USDJPY Put is 2,90% away ... so even if USDJPY starts moving more and changing the current correlation the investor will still have 0,20% "buffer".
One small catch is ... if the investor wishes to see a decent amount is absolute cash terms then the positions would need to be "a little bigger than normal" which would perhaps put a higher strain on margins.