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In this write-up, we emphasize on zero-cost GBP put/CHF call vs. USD put/CHF call switch: Our macro G10 FX portfolio is positioned short GBPCHF, a directional view that marries deteriorating UK cyclical and Brexit unease with any potential upside from CHF appreciation resulting due to weaker equity markets and/or more forceful discounting of SNB policy normalization by rate markets now that the franc is no longer overvalued.
The motivation for mulling an option based expression of the view is that GBPCHF implied vols have been crushed by not only a broad compression of FX risk premia but also an increase in GBP vs. CHF via USD correlations towards historic highs over the past few months of dollar-centric price action in currency markets. Realized vols are also performing at par with or even slightly better than short-dated implied vols, which had motivated a long GBPCHF vs short USDCHF spread suggestion last week.
The choice of USDCHF as the funding leg of that RV is as important as long GBPCHF since realized vols in the pair have consistently disappointed and risk-reversals have been over-priced for USD puts for a while as an artifact of the market’s long memory of the franc de-peg. A directional variant of this vol RV that can better suit many macro portfolios not given to active delta management is a zero-cost long GBP put/CHF call vs. short USD put/CHF call option switch (live options, not delta-hedged).
Conceptually, such a spread expresses a short GBPUSD delta view; premium-neutral switches using identical tenor and moneyness strikes on both legs are possible by,
a) The lower vol base on the GBPCHF leg;
b) The still extant bid for USD puts on the USDCHF skew, and
c) Most importantly, wider forward points on USDCHF after the 60bp+ rise in Treasury yields this year.
For instance, long 3M 2% OTMS GBP put/CHF call vs. short 3M 2% OTMS USD put/CHF call switch, equal CHF notionals on both legs is costless. For comparison, the corresponding 3M 2% OTMS GBP put/USD call equivalent costs 64bp (mid). Courtesy: JPM
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