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FxWirePro: The Key Drivers of EUR/USD, OTC Updates and Hedging Perspectives

The dollar weakened by 0.3% in trade-weighted terms, as the EURUSD surged 0.3% on the week, to end the week at 1.0979. While we reckon that the eurozone’s macro data will continue to be weak, this appears to be priced in by investors, to a greater extent than the weakness that is now emerging in US macro data. Thus, we believe EURUSD has reached a trough, and should stay around current levels in the coming months, we could foresee the key driving forces for hedging before the underlying FX move strengthens gradually towards 1.11 and 1.12 in six and 12 months’ time.

The key driving forces: 

  • The orders received by German industry in August fell by 0.6% compared to the previous month, which is more than expected. Leading indicators such as Ifo expectations also indicate that the downward trend in German industry is likely to continue.
  • ECB minutes on Thursday will give more insights into the ECB easing package , which as it turned out came with significant disagreement within the ECB Governing Council.
  • Focus this week will turn to the 13th round of high-level trade talks between the US and China taking place in Washington on Thursday and Friday . If we get an interim deal we expect a short-term relief in equity markets, see US-China Trade - 60% probability of an interim deal , 2 October 2019. On the other hand, a failure to reach such a deal should put risk appetite under pressure again as US tariffs on USD250bn of Chinese goods are then set to move up from 25% to 30% on 15 October (next week).

The macro data from the eurozone remains far from encouraging, instead they seem to be fragile, it was the growing signs of the US macro weakness that caught investors’ attention last week, and led to a sell-off in the US dollar.

OTC Updates:

The FX OTC hedging markets are also suggesting the same thing, the IVs and risk reversals of the short tenors indicate interim rallies but the major bearish hedging sentiment remain intact.

3m skews are stretched on either side (equal interest in both OTM call and OTM puts), 3m positively skewed IVs have still been signalling downside risks and upside risks as well. Skews stretched towards OTM put strikes signifies hedgers interest in the further bearish risks in the major downtrend.

To substantiate these indications, bearish neutral RRs across all tenors, which is in line with the above-stated bearish scenarios. But one could observe positive shift in 1m tenors which is again as per the 1w skews.

All these indications coupled with the fundamental news and the underlying scenarios are attractively appealing ITM put holders. Contemplating all these factors, we advocate below options strategy.

EURUSD’s upswings are observed from last 4-5 days ever since it has jumped from the lows of 1.0925 levels. However, the interim upswings unlikely to sustain in the long-run as it is struggling for the convincing buying momentum. So, we emphasized the bearish stance in the major trend in our technical section as well.

Hedging Strategies: At spot reference: 1.0975 level, initiate long in 2 lots of EURUSD at the money -0.49 delta put options of 3M tenors, write an (1%) out of the money put option of 2w tenors. 

Those who are sceptic about mild rallies, 3m 1% in the money puts with attractive delta are advised on a hedging ground. Thereby, in the money put option with a very strong delta will move in tandem with the underlying.

Alternatively, shorting futures of mid-month tenors have been advocated with a view of arresting further potential slumps, we now wish to uphold the same strategy. Writers in a futures contract are expected to maintain margins in order to open and maintain a short futures position. Courtesy: Sentrix, Danske & Saxobank

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