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FxWirePro: Implications of Fed and RBA’s actions on swap yields and AUD/USD – Bid bearish neutral RRs and shrinking IVs in PRBS to hedge FX risks

We look for AUDUSD to finish the year around 0.76, so long as markets maintain a very high probability of a Fed interest rate rise in December along with a neutral RBA outlook deep into 2018 and commodity prices remain around recent levels.

 The US dollar index is up 0.1% on the day.

Our RBA outlook (on hold throughout 2018) is anchoring short-maturity interest rates and should keep 3yr swap rates in a 1.80% to 2.30% range, as long as core inflation remains below 2%. Longer maturity rates will largely follow US rates.

OTC outlook and options strategy:

Please be noted that the positively skewed IVs of 3m tenors signify the hedgers’ interests to bid OTM put strikes upto 0.7350 levels (refer above diagram). While bearish neutral delta risk reversal divulges the interests in hedging activities for downside risks remains intact amid mild upswings.

While ATM IVs of 1m expiries are just shy above 7.6%. Hence, it is deemed as the right time to short overpriced OTM puts.

The bearish stance has been substantiated by bearish neutral risk reversals in 1-3m which is an opportunity for put longs in long-term and using shrinking IVs of shorter tenors could be interpreted as an opportunity for writing OTM puts or theta shorts in short run on time decay advantage as the spot FX market reckons the price has downside potential for large movement in the days to come which is resulting option holders’ on competitive advantage.

Accordingly, we had advocated put ratio back spreads a couple of days ago, wherein short leg is functioning as the underlying spot FX keeps spiking.

So, the speculators and hedgers for bearish risks are advised to capitalize on the prevailing price dips and bidding theta shorts in short run and 3m risks reversals to optimally utilize Vega longs.

We advocate weighing up above aspects and uphold the same option strategy on hedging grounds, we eye on loading up with fresh Vega longs for long-term hedging, more number of longs comprising of ATM instruments and ITM shorts in short-term would optimize the strategy.

So, the execution of hedging positions goes this way:

Short 1m (1%) OTM put option (position seems good even if the underlying spot goes either sideways or spike mildly), simultaneously, go long in 2 lots of vega long in 3m ATM -0.49 delta put options. A move towards the ATM territory increases the Vega, Gamma, and Delta which boosts premium.

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