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Last week the Bank of Japan did what it has been doing for some time and had also announced, i.e. to keep yields close to zero. JPY came under pressure.
Accordingly, the bullish influence would be the most direct on the EURJPY, as the BoJ suppressed yen rates vol and the Bund correlation is super strong. The pair is still consolidating just below 130 so the bulk of the EURJPY reaction is still ahead.
Today, at the start of the week it was sufficient for BoJ governor Haruhiko Kuroda to underline once again that the central bank was willing to continue this approach for JPY to ease again. Sometimes it really is surprising how long it takes the market to realize things. Or does the exchange rate reaction simply illustrate how skeptic the market is about JPY these days? Certainly, JPY shorts are very popular amongst speculative investors these days. We would not bet on a recovery in JPY yet.
Achieve topside leverage in medium-term trading a volatile EURJPY move suggests getting topside convexity. A break above 130 would strongly reduce the likelihood of a market reversal below that level. It makes us less reluctant to sell low strikes. Selecting a medium-term expiry to trade a long call/short put risk reversal has several attractive features.
Selling longer-dated options makes it possible to sell a more distant strike and build a zero cost package with a safer downside cushion.
The EURJPY skew is negative and even more so for longer dates so that the short put can be sold at a higher implied volatility. In particular, the term structure of OTM calls is flat and trading lower than ATM vols while the puts’ term structure is higher and steep. Financing 6m cheap calls in selling rich low strikes appeals.
Optimal risk management: A medium-term expiry limits convexity on both sides. On the downside, the limited negative convexity slows the mark-to-market losses. If needed, delta hedging the trade would also be much more convenient.
Cost effectiveness: Although a shorter-dated trade would have more convexity, the zero cost characteristic implies that any topside gain virtually corresponds to infinite leverage (like a standard spot trade where no premium is paid either), with a more secure breakeven.
Buy EURJPY 6m call strike 136, Sell 6m put strike 123 Zero cost (at spot ref: 130.2680).
