FxWirePro: Kiwis clouded by headwinds - Bid 2m NZD/JPY skews and deploy options strips for stiff hedge

NZD faces headwinds, even in a clearly weak USD environment. Domestic growth has weakened, the central bank’s inflation forecasts have been revised materially lower, net immigration is slowing and business confidence has fallen significantly since the change of government.

But with the central bank in a state of transition (new governor, new mandate), over the next couple of months, we don’t see any domestic monetary policy catalysts that would drive material NZD weakness in the near-term.

Bearish NZDJPY scenarios:

1) The housing market slowdown becomes disorderly

2) The immigration rolls over quickly

3) NZ bank funding issues intensify, causing the market to question NZ's ability to attract capital inflow.

Bullish NZDJPY scenarios:

1) Fiscal easing is delivered quickly

2) New RBNZ Governor Orr starts with a surprisingly hawkish bent.

NZDJPY’s recent peak is the latest in a series of lower peaks during the past year (refer above technical chart). The recent decline has potential to push below 75.

Kiwis events this week include inflation, RBNZ monetary policy, business manufacturing index, and from the Japanese side, the BoJ quarterly ‘outlook’ meeting.

Medium-term perspectives: The BoJ tightening may be a long way off, but that won’t stop markets from starting to price it in, supporting the yen and depressing NZDJPY below 74.500 by Q2-end.

This is substantiated by the positively skewed IVs of 2m tenors, if you refer above nutshell, the skewness for the bids are for OTM puts upto 74.500 levels.

Contemplating both bearish and bullish trends of this underlying pair, to participate in the puzzling swings, we advocate option strips strategy that contains 3 legs of vega longs (2 puts plus 1 call). The option strips that likely to fetch desired yields regardless of the trend but more potential on southwards by arresting bearish risks.

As shown in the diagram, the execution goes this way: Initiate 2 lots of 1m longs in Vega put options, simultaneously, add 1 lot of Vega call options of the similar expiry, the strategy is executed at net debit.

One can deploy this strategy both on trading as well as hedging grounds. Please be noted that the strategy is likely to derive positive cashflows regardless of the underlying spot FX moves with more potential on the downside.

Currency Strength Index: FxWirePro's hourly NZD spot index is flashing at 95 levels (which is bullish), while hourly JPY spot index was at shy above 17 (neutral) while articulating (at 10:05 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex.

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