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The push and pull of offsetting factors that had nudged us towards a more balanced view on vol were on full display this week. EM gamma spiked sharply as the shakeout in dollar shorts played out most violently in heavily-positioned in carry trades in EM and lifted delivered vol, but G10 vols fell as the sapping of bearish USD momentum prompted liquidation of USD puts, especially versus European currencies, USDTRY has been the pair to pop up the second highest vols (refer above chart).
Buy the tail Turkish lira implied volatility and risk reversals are among the highest in emerging markets. However, relative to recent history, they are not high in their own right.
The current 3m implied vol (12.5) could spike to the 16-20 area if accelerated depreciation did occur, while risk reversals could easily rise by 1-2 vol points.
This lends itself to owning volatility, and given the difficulty in ascertaining the probabilities of a “spike followed by a recovery” versus a “trend” move higher in USDTRY, we prefer a one-touch structure over a European digital.
The execution: Buy USDTRY 3m one-touch knock-in 4.35 Indicative offer: 10% (spot ref: 3.6684); Maximum leverage: 10 times.
Risks are limited to the extent of initial premium paid. The maximum loss is limited to the premium paid in the event that USDTRY does trade at, or above, the 4.35 strike at any time throughout of the life of the option.
