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FxWirePro: One USD/CHF RKOs to target multi-faceted objectives

In this write-up, we emphasize on USD put/CHF call spreads and/or RKOs: Possessing standalone OTM USD puts/CHF calls seems to be an arduous proposition owing to the triple whammy of negative carry on points, the recent surge in short-dated vol and steep risk-reversals.

While riskies in most USD-majors have re-shaped in the direction of USD puts as the broad dollar has weakened, USDCHF is one of the most extreme examples of elevated USD put skews, which in turn results in one of the highest leverage ratios on USD put/CHF call spreads in recent memory (refer above chart).

At current market (spot ref. 0.9285), a 2M USDCHF put 0.92 /0.90 USD put/CHF call spread costs 65bp, offers 3.4x max gearing and 40%+ cost savings relative to the standalone 0.92 strike vanilla call (refer above table for a selection of USDCHF put spreads with decent optics).

An interesting twist on bullish CHF structures is to consider alternative CHF-crosses such as AUDCHF and NZDCHF that avoid the dollar beta of USDCHF, yet offer useful anti-risk/anti-commodity exposure and are consistent with the baseline views of steady declines in both the antipodean currencies through 2018.

Net vega buying structures such as CHF call spreads also benefit from elevated AUD vs. CHF implied correlations i.e cheap CHF cross vols: the 2nd chart demonstrates that AUDCHF and NZDCHF implieds are priced 2-sigma cheap to historical norms relative to USDCHF and are primed to correct sharply higher if risk markets hit an air pocket.

For investors already short USDCHF in cash, short tenor USD put/CHF call reverse knock-outs (RKOs) with rebate can be a worthwhile levered overlay. RKOs exploit the same vol surface characteristics as vanilla spreads, but with much higher gearing.

Rebate RKOs repay the premium back if the barrier triggers, which is a useful feature to incorporate into option structures given that the market’s persistent forecast error through the dollar sell-off has been to underestimate the pace and extent of the move. Doing so ensures an asymmetric payout profile of either zero P/L in an aggressive CHF rally, in which case the underlying cash position should be outperforming, or positive P/L in moderate CHF rallies; the downside is the loss of only the small premium amount if CHF weakens.

At current market (spot ref. 0.9285), consider a 1M USDCHF put 0.92 strikes with 0.89 RKO with a rebate that costs 33bp and offers 10x max gearing.

Being a pre-Italian election expiry, 1M exposes the trade to less event risk and retains most of the premium value even after 3-weeks of the unchanged spot. Courtesy: JPM

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