FxWirePro: Bid 3m CAD/JPY IV Skews and Deploy Options Strips on Status-quo BoJ

We should give a mention to the Bank of Japan’s (BoJ) rate meeting. Even though the central bank council did not decide on any new measures it cannot ignore the global tendency towards more expansionary monetary policy, which is why it added in its statement that "...the Bank will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost".

Nor can the Board keep its eyes closed to the JPY’s appreciation trend, particularly against the background of an inflation rate that disappointed with a fall to 0.6% in June (rate excluding fresh food). Even if the BoJ could not bring itself to implementing new expansionary measures today this is likely to be simply a matter of time.

The Bank of Japan left its key short-term interest rate unchanged at -0.1 percent at its July meeting and kept the target for the 10-year government bond yield at around zero percent, as widely expected. Policymakers underlined that they would not hesitate to take additional easing measures if the economy loses momentum for achieving the central bank's 2 percent inflation target. CADJPY has slid from the highs of 83.210 to the current 82.339 levels, the major trend is likely to extend downswings up to 80 levels upon intensified selling sentiments.

OTC Updates and Options Strategy: 

The positively skewed CADJPY IVs of 3m tenors have still been signaling bearish risks, the hedgers’ interests to bids for OTM put strikes up to 80.000 levels indicating downside risks in the medium terms (refer above chart). Please also observe the above technical chart for the major downtrend. Accordingly, we advocated options strips strategy to address any abrupt upswings in short-run and the major downtrend.

We’ve been firm to hold on to this strategy on both trading as well as hedging grounds, unlike spreads, combinations allow adding both calls and puts at a time in our strategy.

Buy 2 lots of 3m at the money delta put option and simultaneously, buy at the money delta call options of similar tenors. It involves buying a number of ATM call and double the number of puts. Please be noted that the option strip is more of a customized version of options combination and more bearish version of the common straddle.

Huge profits achievable with this strategy when the underlying currency exchange rate makes a strong move on either downwards or upwards at expiration, but greater gains to be made with a downward move. Hence, any hedger or trader who believes the underlying currency is more likely to spike upwards in short-run but major downtrend can go for this strategy. Cost of hedging would be Net Premium Paid + brokerage/commission paid. Courtesy: Sentrix & Commerzbank