FxWirePro: AUDUSD drivers and OTC dense bearish setup for H1’2019 prompts ‘diagonal put spreads’

Even with a little New Year rebound, AUDUSD’s outlook for 2019 seems quite bearish amid mild rallies ahead of Fed’s and RBA’s monetary policies, but we continue to foresee modest depreciation towards 0.68 by end-2019. While JPM forecasts assume that global growth will remain slightly above trend into 2019. And while China’s growth has down-shifted another gear, this has occurred mostly through the trade channel, with stabilization in FAI and shuttering of domestic commodity production proving supportive for global iron ore and coal prices.

Positive terms of trade dynamics, therefore, anchor the longer-run FV metrics for AUD at relatively healthy levels. We expect the currency will trade at around a 10% discount to such estimates this year, driven by narrowing (more negative) rate spreads, and re-escalation of trade tensions. But meaningful depreciation beyond that seems to require a US/global recession: AUDUSD 1M correlation to US equities is already in the upper quartile or observations over the last 15 years (refer 1stchart). Through most of December, the correlation traded in the 90thpercentile.

OTC updates: Let’s just quickly glance through OTC outlook of AUDUSD, before deep diving further into the strategic framework.

Please be noted that the positively skewed IVs of 6m tenors signify the hedgers’ interests to bid OTM put strikes up to 0.67 level which is in line with the above bearish scenarios (refer 1st nutshell). 

While mounting numbers of bearish risk reversals and bearish neutral RRs across all tenors that are also in sync with the bearish scenarios refer 2nd(RR) nutshell.

In a nutshell, AUD OTC hedgers’ sentiments substantiate that their risk mitigating activities for the downside risks have been clear.

Options Strategy: Considering the above factors, diagonal put spreads have been advocated to mitigate the Fx risks with a reduced cost of trading.

The execution of options strategy: Short 1m (1%) OTM put option with positive theta (position seems good even if the underlying spot goes either sideways or spikes mildly), simultaneously, add long in 2 lots of delta long in 3m (1%) ITM -0.79 delta put options. A move towards the ATM territory increases the Vega, Gamma, and Delta which boosts premium. 

The rationale: We have advocated delta long puts on hedging grounds for the long term downside risks, comprising of more number of ITM long instruments and theta shorts with narrowed tenors to optimize the strategy. Thereby, deep in the money put option with a very strong delta will move in tandem with the underlying. Theta shorts in OTM put option would go worthless and the premiums received from this leg would be sure profit. Courtesy: Sentrix, JPM, and Saxobank

Currency Strength Index: FxWirePro's hourly AUD spot index is inching towards 64 levels (which is bearish), hourly USD spot index was at -118 (bearish) while articulating (at 07:05 GMT). 

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex