FxWirePro: Luring Vega longs in AUD/USD as IV skews move in tandem with RRs ahead of RBA – Hedge using Reverse Put Spreads

We reckon the USD rebound appears to be stalling despite the upbeat US CPI and the rate expectations have remained largely unchanged. A rate hike in December is still only priced in at only two thirds to give US yields an additional boost. 

Please be noted that the positively skewed IVs of 3m tenors signify the hedgers’ interests to bid OTM put strikes upto 0.77 levels (refer above diagram).

While bearish neutral delta risk reversal divulges the interests in hedging activities for downside risks remains intact amid mild upswings.

Well, the bearish stance has been substantiated by AUDUSD's rising IV in 1-3m which is an opportunity for put longs in long term and using shrinking IVs of shorter tenors with bearish neutral delta risk reversal can be interpreted as an opportunity for writing OTM puts or theta shorts in short run 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 couple of days ago, wherein short leg is functioning as the underlying spot FX keeps spiking.

AUDUSD medium term perspectives: It has recently broken out the psychological 0.80 level but could not sustain above this level.

For now, it is worthwhile not only to watching the key 0.8000 level breach but also the sustenance above this level. Will it attempt another break above, as it did last night? AU GDP will be key today, as will be USD direction.

As the RBA remains firmly on hold, as widely expected, and the US dollar rises on tighter Fed policy, then AUDUSD could fall to 0.76 by year end.

So, the speculators and hedgers for bearish risks are advised to capitalize on the prevailing rallies and bid on 1-3m 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 2w (1%) OTM put option as the underlying spot likely to go either sideways or spike mildly, simultaneously, go long in 2 lots of vega long in 2m ATM -0.49 delta put options.

A move towards the ATM territory increases the Vega, Gamma and Delta which boosts premium.