FxWirePro: A glimpse on BRL vol calendar expression

When focusing on pure vol plays, a natural implementation for the short EMFX vol theme is via delta-hedged calendar spread, where the short-vol leg benefits from the vol carry and the long leg serves as a hedge. At current market, BRL-crosses stand as the best calendars with their wide vol premia and contained curve roll-down (refer 1st chart). SVM based gamma trading model sees BRL vols as strong tactical sell (TWD being the only other pair among the G10 and EM pairs that we track in the SVM model). Moreover, across a set of liquid EM-pairs BRL screens as one of the best systematic performers (refer 2nd chart).

The implementations for the milking BRL vol carry (Vol calendar expression): To asses a risk from sell-offs to the short gamma leg we analyze past episodes of SSR vote optimism and disappointments particularly focusing on the drawdowns that occurred during the sharp selloffs (refer 3rd chart). The so-called “Temer tapes” in May 2017 and the April/May 2019 vote delay disappointment show 3vol and 2vol losses, respectively. The losses got pared within 1 quarter. A back of the envelope calculation indicates that a sharp, one-day 2.5% move could correspond to about 1.5 vol loss even if no change in the BRL vols. The current 3M implied realized vol gap (>4vols wide) should well sustain a 1.5vol hit on the bottom line assuming that the large spot gyrations do not persist.

Keeping in mind the risks, we recommend: Delta-hedged short 3M 25 strangle@ 11.95/12.3ch vs. long 12M straddle in USDBRL @12.9ch indic vols, in vega neutral notionals. Courtesy: JPM