FxWirePro: Deploy NZD/JPY 2:1 put ratio back spread ahead of RBNZ

After a solid two-week rally, NZDJPY is in consolidation mode around 75.0, but with potential for higher. 

The Japanese calendar highlight this week is the batch of data on Friday: Tokyo CPI, jobless rate, retail sales, and industrial production. 

Three months ahead: We remain bearish, targeting sub-72 by year-end, as BoJ de facto tapering continues. 

NZDJPY’s trend has been within the tight range of 76.859 – 74.040 levels, but the pair is having more bearish traction and expected to depreciate upto 72.5 levels by 3Q’19 as RBNZ outlook remains on hold throughout 2018. NZD has fallen victim to continued weakness in EM and high beta FX. The correlation between NZD and ADXY, in particular, has strengthened materially in 2018.

We see a reasonable chance of a rate cut from the RBNZ (approx. 30%), it seems likely that this is a prospect for 2019, and will require a further loss of momentum in the activity data. The RBNZ laid out a clear path to a rate cut at the August MPS, which required that growth fails to stabilize over 2Q/3Q. 

BoJ tightening may also be a long way off, but that won’t stop markets from pricing it in, supporting the yen and pushing NZDJPY down below 72.00 by year-end. Hence, we advocate below options strategy on hedging grounds.

Options Hedging Strategy (NZDJPY):

The above-stated bearish stances seem to be factored-in the 3m positively skewed implied volatilities that indicate the hedging sentiments for the lingering bearish risks. Bids are for OTM puts upto 72.00 levels. 

As a result, we construct suitable options strategy favoring slightly on bearish side. 

Initiate 2 lots of 2m longs in (1%) in the money -0.79 delta put options, simultaneously, short 1 lot of (1%) out of the money put options of the narrowed expiry (preferably 2w tenors), the strategy is executed at net debit. 

Writing OTM put options capitalizing on prevailing upswings would most likely mature worthless. Thus, one can pocket the initial premiums on such short option legs and reduces the cost of buying long legs. 

Deep in the money call with a very strong delta will move in tandem with the underlying. 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.

Currency Strength Index: FxWirePro's hourly NZD spot index is inching towards -3 levels (which is bullish), while hourly JPY spot index was at -110 (bearish) while articulating (at 11:32 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex