FxWirePro: Cable’s hedging sentiments still fragile despite momentary bullish bids – Capitalize on 3m/6m OTC setup to execute wise hedge

The cable extended a comprehensive recovery, although appears to be minor that we have seen over the last couple of days, especially after PM May hinted she and her office would take over the negotiations with Europe.

OTC Outlook:

Before we proceed further, let’s just glance through the hedging outlook in FX OTC markets and devise strategies.

Please be noted that the positively skewed IVs of 6m tenors signify the hedgers’ interests to bid OTM put strikes upto 1.27 levels.

Implied Volatilities of 3m tenors are shrinking lower, shy below 8% on a lower side, which is perceived to be conducive for option writers. Whereas 6m-1y IVs are on rising mode, well above 8.25%, rising IVs are good for options holders.

While the positive shift in delta risk reversal numbers (across 1-3m tenors) indicates the mild recovery is anticipated in the underlying movements amid the bearish hedging activities for the downside risks remains intact in a medium-term perspective.

Strategic framework:

Amid this hedging outlook, 1% out-of-the-money GBPUSD puts of 2w tenors seem to have been exorbitantly overpriced. As you could observe from the above nutshell 2w OTM puts are priced 12.5% more than that of its NPV (net present value), whereas, 2m implied volatilities of this pair is just shy above 7.57%. Hence, it is perceived as the disparity between IVs and the pricing of option.

While contemplating above OTC bids, put spread like structures are advocated, wherein short leg is most likely to function during low IV environment coupled with the prevailing rallies of the underlying spot FX continue or remain above from the spot levels, we would like to uphold the same strategy on hedging grounds.

Both the speculators and hedgers for bearish risks are advised to capitalize on the prevailing price rallies and bidding theta shorts in short run (3m IVs) and 6m risks reversals to optimally utilize delta longs.

On hedging grounds, fresh delta longs for long-term hedging comprising of ATM instruments and OTM shorts in short-term would optimize the strategy.

So, the execution of hedging positions goes this way:

Short 3m (1%) OTM put option (position seems good even if the underlying spot goes either sideways or spikes mildly), simultaneously, initiate longs in 6m ATM -0.49 delta put options. A move towards the ATM territory increases the Vega, Gamma and Delta which boosts premium.

Thereby, the above positions address both upswings that are prevailing in the short run and bearish risks in long run by vega longs.

The political and economic backdrop remains supportive of sterling’s underperformance. We continue to be short but take partial profits by unwinding the GBPUSD expression of the trade since this is currently in the money but has only less than a week to expiry and is close to the strike.

Currency Strength Index: FxWirePro's hourly GBP spot index is inching towards 65 levels (which is bullish), while hourly USD spot index was at -119 (bearish) while articulating (at 12:48 GMT). For more details on the index, please refer below weblink:

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