FxWirePro: Deploy ‘Diagonal Put Spreads’ To Hedge NZD/JPY Ahead of RBNZ

This week, RBNZ’s monetary policy is scheduled, although it is unlikely to be dramatic for markets, since net economic developments since May are roughly neutral, the Kiwis central bank may further expand its asset purchase programme. 

NZDJPY is stuck around 70.00, with a glimmer of downside risk as global sentiment becomes more cautious amid second wave of Covid-pandemic.

The 69.5/70.5 range that has contained this cross has held but a break below 69.85 spells lower, especially on a dovish MPS. The significant support is seen at 69.55 and resistance at 71.70 levels.

OTC Updates, Trade and Hedging Recommendations:

The positively skewed NZDJPY IVs of 3m tenors signify the downside risks, the bids for OTM put strikes up to 68 levels indicates hedgers are inclined for further downside risks. The major downtrend continuation shouldn’t be panicked the broad-based bearish outlook amid minor rallies. 

Hence, it is conducive for OTM put writers capitalizing on short-term rallies so as to reduce long-leg meant for downside hedging.

The execution of strategy goes this way: Initiate longs in at the money -0.49 delta put options of 3m tenors, simultaneously, short (1%) out of the money put options of the narrowed expiry (preferably 2w tenors), the strategy is executed at net debit (activated when spot reference: 70.120 levels while articulating).

Well, a higher (absolute) Delta value is desirable on long leg in the above stated strategy. Whereas, the Theta is positive on short leg; as the time decay is good for an option writer (that’s why we’ve chosen narrowed expiry). The short side likely to reduce cost of hedging with time decay advantage on short leg, while delta longs likely to arrest potential bearish risks.

Alternatively, shorts in the mid-month futures have been advocated with a view of arresting potential downside risks. Courtesy: Westpac

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