FxWirePro: Is EUR/JPY skews mispriced? Vol smile opportunities in EUR/USD and USD/JPY

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FxWirePro: Is EUR/JPY skews mispriced? Vol smile opportunities in EUR/USD and USD/JPY

Tuesday, January 10, 2017 7:30 AM UTC

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The volatility smile most often signifies that traders are willing to pay higher implied volatility prices as the strike price grows aggressively out of the money.

Among G3 FX volatility space, EURJPY 3m-6m risk reversal is one of the highest compared with ATM volatility of the peer group, suggesting euro calls that sell topside skew.

The EURJPY volatility surface is offering very attractive opportunities because the skew on the 6m and 1y is currently excessive (refer above graph).

Is EURJPY IV skew mispricing? If we consider that the options market is pricing EURJPY risk reversals (RR) as the sum of EURUSD and USDJPY RR, the triangle is perfectly priced.

The implied volatility of 6m and 1y 25-delta strikes is trading about 3 volatility points higher than ATM volatility, which supposes that the implied volatility should be strongly negatively correlated with the FX rate.

Since 2013, the EURJPY RR has strongly mean reverted towards the vol/spot correlation. However, this correlation has been about zero for a few weeks, such that EURJPY 6m skew is now disconnected from its fair value.

Splitting the EURJPY RR into EURUSD and USDJPY components, like the market, exhibits the source of this mispricing. The EURUSD 6m RR is trading at -1.8 and the USDJPY at -1.1. The former is consistent with the EURUSD price action, which actually saw downside volatility.

However, USDJPY has indeed been positively correlated with its volatility, hence the EURJPY mispricing comes from the yen side. Investors could directly consider selling the USDJPY excessive skew, but we recommend selling the EURJPY skew instead. It offers a larger risk premium (due to the fairly priced EURUSD smile component), which is opportunistic given our bullish bias on the spot.

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UNITED STATES W/E ECRI WEEKLY INDEX* INCREASE TO 144.8 VS PREV 143.9

CANADA'S S&P/TSX COMPOSITE CLOSED AT 15,180.72, DOWN -0.55%

BRAZIL'S BOVESPA CLOSED AT 64,610.07, DOWN -0.51%

NASDAQ UNOFFICIALLY CLOSES DOWN 3.94 POINTS, OR 0.06 PERCENT, AT 6,386.06

S&P 500 UNOFFICIALLY CLOSES DOWN 1.23 POINTS, OR 0.05 PERCENT, AT 2,472.22

DOW JONES UNOFFICIALLY CLOSES DOWN 33.25 POINTS, OR 0.15 PERCENT, AT 21,578.53

CFTC-SPECULATORS INCREASE CBOT US 5-YEAR TREASURY FUTURES NET SHORT POSITION BY 6,731 CONTRACTS TO 282,325 IN WEEK ON JULY 18

CFTC-SPECULATORS RAISE CBOT US 10-YEAR TREASURY FUTURES NET LONG POSITION BY 25,302 CONTRACTS TO 282,329 IN WEEK ON JULY 18

CFTC-SPECULATORS INCREASE CBOT US 2-YEAR TREASURY FUTURES NET SHORT POSITION BY 17,400 CONTRACTS TO 274,213 IN WEEK ON JULY 18

CFTC-SPECULATORS INCREASE CBOT US ULTRABOND TREASURY FUTURES NET SHORT POSITION BY 7,736 CONTRACTS TO 63,676 IN WEEK ON JULY 18

CFTC-SPECULATORS RAISE CBOT US TREASURY BONDS FUTURES NET LONG POSITION BY 1,018 CONTRACTS TO 51,450 IN WEEK ON JULY 18

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Economics Monitor

July 21 14:30 UTC Released

USECRI Weekly Annualized*

Actual

144.8 %

Forecast

2.4 %

July 21 14:30 UTC Released

USECRI Weekly Index*

Actual

2.6 %

Forecast

143.9 %

July 24 00:30 UTC 832832m

JPForeign Direct Investm't*

Actual

Forecast

52.4 bln $

July 24 07:00 UTC 12221222m

FRMarkit Serv Flash PMI

Actual

Forecast

56.7 %

56.9 %

July 24 07:00 UTC 12221222m

FRMarkit Mfg Flash PMI

Actual

Forecast

54.6 %

54.8 %

July 24 07:00 UTC 12221222m

FRMarkit Comp Flash PMI

Actual

Forecast

56.4 %

56.6 %

July 24 07:30 UTC 12521252m

DEMarkit Service Flash PMI

Actual

Forecast

54.3

54.0

July 24 07:30 UTC 12521252m

DEMarkit Mfg Flash PMI

Actual

Forecast

59.2

59.6

July 24 07:30 UTC 12521252m

DEMarkit Comp Flash PMI

Actual

Forecast

56.3

56.4

July 24 08:00 UTC 12821282m

RUMarkit Mfg Flash PMI

Actual

Forecast

57.2 %

57.4 %

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