FxWirePro: Aussie looks puzzled amid mixed bag of indicators ahead of Fed – Bid 3m AUD/USD OTC and deploy diagonal debit spread

The Aussie has been choppy this month ahead of Federal Reserve’s monetary policy that is scheduled for today, the consensus is 25 bps cut, absorbing mixed signals from US interest rate expectations and US-China trade developments. The prospect of more Fed easing before year-end should see real rate spreads work in the favour of AUDUSD near term (refer 1stchart). In addition, the existing projection sees a better outlook for global growth in 1H’20 vs 2H’20 (average quarterly SAAR rates of 2.30% vs. 2.65%), so fears around global recession could dissipate into year-end if activity data show signs of stabilization and improvement. 

If realized, this could also help AUD consolidate for the next couple of months. In the medium term, however, we still expect AUD to resume its decline towards USD0.65 as ongoing question marks about the resilience of global growth and the trajectory of the domestic economy underpin a less optimistic outlook for AUD. 

The dip below 0.6700 to a 10 year low came after the USDCNY break of 7.00 and the US’s angry reaction in the labelling of China as an FX manipulator. But rates markets are likely to remain aggressively priced for further easing at both the Fed and RBA, so enough downside is probably priced in for AUD in near-terms of yield spreads and spec shorts are large. Meanwhile, although iron ore prices have tumbled this month, this follows Australia’s record trade surpluses and large resource company dividend payments which should lend some support to AUD in early-mid Sep, to the 0.6850/0.6900 area. 

Contemplating the above factors, we will now quickly run you through OTC outlook of AUDUSD, before proceeding further into the options strategic framework.

Please be noted that the positively skewed IVs of 3m tenors still signify the hedgers’ interests to bid OTM put strikes up to 0.66 level which is still in line with the above bearish trend (refer 1st nutshell). 

Please also be noted that the minor positive shift in risk reversals (RRs) of the shorter tenors and bearish RRs of the longer 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 risk has been clear. 

Accordingly, diagonal put spreads are advocated to mitigate the downside risks with a reduced cost of trading.

The execution of options strategy: Short 2w (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. 

The rationale: Bidding above 3m IV skews, we have advocated delta long puts for the long term on hedging grounds, comprising of more number of ITM long instruments and theta shorts with narrowed tenors for 1m lower IVs to optimize the strategy.

Bearish outlook with rising volatility good for the option holder. 

While put writers would be on the upper hand on theta shorts in OTM put options that would go worthless on lower IVs as the underlying spot FX keeps rising, Thereby, the premiums received from this leg would be sure profit.

We keep reiterating that the deep in the money put option with a very strong delta will move in tandem with the underlying. Courtesy: Sentrix, JPM, and Saxobank

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