FxWirePro: EUR/USD vega spreads job done – option strips well placed as hedging material

Euro has been gaining on the back of all adverse news to dollar, that was the time when we advised vega spreads to tackle upside risks. Now our vega spread strategy has been taking care of current upswings.

Rationale: But for now, from nutshell showing ATM volatility and delta risk reversal, it divulges that the fact that pair would experience little downside pressure in next I month future. The higher side volatility of EURUSD ATM contracts for next 3 months is projected. Although trend is puzzling on either sides the bearish momentum is likely to hold on. Huge volatility is expected over next 2-3 months.

How to execute: The spot EURUSD is flashing at 1.1033 and we think the prices will make a significant move most likely in a downward direction. At the money 7D calls (strike 1.1502) are trading at US$ 914.70 and it is recommended buying 1 lot (size 100,000). At the money 15D puts (strike 1.1502) are trading at US$ 1263.19 lots (same size 100,000 of each lot) are recommended. So thereby we've constructed option strip position at a cost of US$ 3441.08.

How does it work: If EURUSD exchange rate at expiry would still remain at around 1.1500 levels, then the options in both legs would expire worthless and this strategy goes in vein. But on the flip side, if the pair trading at 1.1470 which is the near term support by the time of expiration, then our at the money calls will be in the money and worth more premiums while the puts will expire worthless. The value of the calls will partially offset the initial investment for a total loss. If the pair trades at expiration slightly higher than that level, then the calls will be worth even more while the puts expire worthless. The value of the calls would be greater than the initial investment and our strategy will have made profits overall.

If the pair is trading below prevailing exchange rate (1.1500) by the time of expiration, then the calls will expire worthless while the puts will be worth more. The value of the puts will offset the initial investment and you will break even. By the time of expiration if the pair is trading 1.0966 levels which is our strong support levels, then the calls will expire worthless while the puts will be in the money and worth more. The premiums of the puts would be greater than the initial investment and the strategy will have made net profit overall.