FxWirePro: Bid 1m Cable skews and RRs to deploy options straps on both hedging and speculative grounds

It’s important to recognize that a less assertive BoE outlook is not the only factor weighing on GBP. In particular, the GBP TWI has now given back 80% of the gains it made following the hawkish September MPC whereas the rate market has retraced by less than a third (based on the Dec 19 short-sterling contract).

GBPUSD continues to benefit from Brexit optimism. The Times’ headline this morning - ‘Britain close to Irish border deal’ says it all. Maybe the deal is more a can-kicking exercise than a long-term solution but if it means progress in talks with the EU then it’s good for sterling. Consequently, we reckon that cable’s risk-reversals are too low.

OTC outlook and options strategy:

Let’s glance at sensitivity tool, the positive shift in risks reversals that indicate the bullish risks in underlying spot FX prices.

Positively skewed IVs of 1m tenors have been well balanced and signifies the hedgers’ interests of OTM call/put strikes that means the ATM calls higher likelihood of expiring in-the-money while shrinking implied volatilities in longer tenors are unfavorable to options holders’ advantages. The shift in positive risk reversals indicate hedgers bid for bullish risks. ATM IVs are still stuck between 7.5 to 8.1% range for 1-6M tenors.

Hence, in order to arrest this upside risk that is lingering in intermediate trend and major declining trend, we recommend options strap strategy that favors underlying spot’s upside bias and mitigates any abrupt bearish risks.

So, we recommend building the FX portfolio exposed to this pair with longs positions in 2 lots of 1M ATM 0.51 delta calls and 1 lot of ATM -0.49 delta puts of 1m expiries, these options positions construct smart hedging at net debit.

As shown in the above diagram, if you look at the above nutshell that portrays payoff structure, one would be convinced that the strategy is likely to mitigate both bullish as well as bearish risks irrespective of spot moves. However, on speculative grounds, more potential is foreseen on the upside. Please note positive cashflows whether underlying spot keeps flying or dipping.

Currency Strength Index: FxWirePro's hourly GBP spot index is inching towards 112 levels (which is bullish) ahead of UK’s manufacturing PMI prints. While hourly USD spot index was at shy above 31 (bullish) while articulating (at 08:02 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex

Hence, bulls of this pair are most likely to extend rallies upon our above stated technical rationale.

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