FXO Market Update - Will FED deliver?

Last week’s BoJ was a big nonevent while ECB hiked by 50bps, market was split between 25 and 50bps, but we didn’t see much reaction in the market. EURUSD has been trading in a 100 pip range over the events and we don’t expect much action before FED tomorrow. The curve play from last Tuesday turned out pretty good which will result in a long 3 week 1.00 put that we paid net 18 pips for if EURUSD can stay between  1.00 and 1.03 up to expiry.

USDJPY has traded lower over the last days on back of recession fears and lower yields. Front end vols have traded lower as some event risk has been priced out and the curve trades pretty flat with 1 month vs 3 months spread trading flat for the first time in three months, both 1 month and 3 months trades around 10.25. The spread was trading at a 2 vol premium for the 1 month about a month ago. Market is expecting a 75bps hike from FED tomorrow but with risk of a dovish tilt which could be enough for USDJPY to challenge the 134.25-135 support area. We like to buy USDJPY puts for a test of the support. 1 month Risk reversal trades 1.2 for puts so buying put spread gives good discount to just buying a plain put.

Buy 1 month 135.00 USDJPY put
Sell 1 month 132.00 USDJPY put
Cost 74 pips
The 135 put cost 114 pips

Alternative buy a put-fly

Buy 1 month 135.00 USDJPY put in 1 mio
Sell 1 month 132.00 USDJPY put in 2 mio
Buy 1 month 129.00 USDJPY put in 1 mio
Cost 52 pips

Spot ref.: 136.60

• The Top/Bottom charts shows the top 5 and bottom 5 values/changes for at-the-money vol, risk reversal (RR) and risk premium of the 45 currency pairs we are tracking.
• Risk premium: Implied (Imp) minus realized volatility. A positive risk premium means implied volatility trades above realized volatility, i.e. the implied volatility can be seen as “rich”.
• Change: The difference between current price/volatility and where it closed 1w ago.

FX Options Trading:

You should be aware that in purchasing Foreign Exchange Options, your potential loss will be the amount of the premium paid for the option, plus any fees or transaction charges that are applicable, should the option not achieve its strike price on the expiry date

If you write an option, the risk involved is considerably higher than buying an option. You may be liable for margin to maintain your position and a loss may be sustained well in excess of the premium received.

By writing an option, you accept a legal obligation to purchase or sell the underlying asset if the option is exercised against you; however far the market price has moved away from the strike. If you already own the underlying asset that you have contracted to sell, your risk will be limited.

If you do not own the underlying asset the risk can be unlimited. Only experienced persons should contemplate writing uncovered options, then only after securing full detail of the applicable conditions and potential risk exposure.

Learn more about FX Options:

Forex Options – An introduction

Forex Options – Exotic options