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The yen has erupted higher more recently than that (up 16% vs USD and 25% against GBP in 1H 2016 for example). That’s a reminder that when a currency is as cheap as the yen (USDJPY PPP is at 103 according to the OECD) it can spike pretty sharply. It is kept at current undervalued levels by the commitment of the BOJ to target a 2% inflation rate and anchor bond yields. We see only a small chance of that commitment waning in 2018 because the inflation rate won’t get anywhere near 2%, but the net result is a huge skew in the range of outcomes for the USDJPY. The base case scenario is another year in a narrow range.
Sell a 1m USDJPY straddle vs buying a 1m 25D strangle: As set out in the introduction, we do not regard USDJPY as being an obviously anti-risk currency pair when it is the back up in US bond yields which is hitting risk markets. Both currencies have been used as funding vehicles in recent months and so deleveraging should support both USD and JPY.
Meantime, while a period of heightened vol will bring Japan's current account surplus into play to the benefit of the yen, this dynamic is likely to be countered by wider US-Japan bond spreads that will support Japanese demand for UST. So USDJPY could be held in a relatively tight range by this push and pull of equivalent forces even if risk markets continue to correct.
In our view, therefore, front-end USDJPY vols are a relatively attractive sell following their recent spike, albeit in limited downside form and as an adjunct to an outright defensive position elsewhere in the portfolio.
Our preference is to sell a 1m ATM straddle vs buying a 1m 25D strangle –this benefits from consolidation in the spot but has limited maximum loss in the event of a major break-out.
Sell a 1m USDJPY ATMF (108.75) straddle, buy a 1m 25D strangle (111.10/106.65). Receive a net 1.40% in premium. (Spot reference 109.01).
Currency Strength Index: FxWirePro's hourly USD spot index has shown 64 (which is bullish), while hourly JPY spot index was at 87 (bullish) while articulating at 09:17 GMT. For more details on the index, please refer below weblink:
http://www.fxwirepro.com/currencyindex.
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