FxWirePro: A correlation to balance the odds between GBP/USD and USD/JPY

The pound slipped to a fresh one-month low against the U.S. dollar on Wednesday, despite the release of upbeat U.K. data as investors remained cautious ahead of the Federal Reserve’s policy decision due later in the day.

While USDJPY dropped to the nearly one-month lows after the BoJ mentioned earlier today that it was abandoning its target to increase the monetary base and left interest rates unchanged at minus 0.1%.

For now, the dollar traders turned out to be on the defensive mode as the focus shifted on Fed’s monetary policy meeting.

If you look in for buying USDJPY calls and GBPUSD puts simultaneously, and if the current positive correlation holds, at least one would go in the right direction.

It turns out that the skew in both pairs is offering interesting pricing conditions for regular knock-in (KI) options. The KI levels are set to obtain activation probabilities of about 70%.

The sum of the two exotic premiums (trading both scenarios conditionally - probability about 70%) is smaller than the cheapest vanilla (trading the GBP scenario unconditionally).  

Risks: No activation

Buy USDJPY 2m call strike 103 knock-in 98.50, indicative offer: 0.27% (vs 1.16% for the vanilla call, spot ref: 100.736).

Buy GBPUSD 2m put strike 1.2840 knock-in 1.3150, indicative offer: 0.30% (vs 0.76% for the vanilla put, spot ref: 1.2981).

Investors buying knock-in options cannot lose more than the premium initially invested. However, the USDJPY call and the GBPUSD put will be activated only if their respective underlying FX rates hit 98.50 and 1.3150 on expiry.