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FxWirePro: Delta-hedged 1:1.5 ratio ATMF/25D call spread and directional 1:2 RKO ratio call spreads of USDMXN

We take the opportunity to analyse what generally works on the MXN vol surface, on a back-tested basis and from a pure vol standpoint. The 1st chart analyses a variety of structures, all for 6M maturities. 

For instance, selling RRs (delta-hedged) works orders of magnitude better than selling ATM vol (1st chart - bottom, Sharpe Ratio of 0.87 vs. 0.15 over past 5-yrs). Better yet, 1*1.5 ratio USDMXN call spreads (delta-hedged) have been notably a high Sharpe Ratio (1.66) trade to hold over the years. Being long ATM vs. short OTM calls at near vega neutral notionals, the 1*1.5 ratio call spread structure is also well positioned to be selling topside OTM vols, which now are priced heftily after the latest vol explosion. Also, 1*1.5 ratio calls come near the optimal ratio to maximize Sharpe (refer 2nd chart). At a Sharpe around 0.75, ratio USD put spreads have been decent trades, but nothing remotely close to the ratio USD call spreads. 

 Buy delta hedged 6M USDMXN 1*1.5 ratio ATMF/25D call spread @15.1 choice vs. @17.1/17.35 indic vols. 

Directional 1*2 ratio call spreads and RKO calls: As an equivalent directional expression for those who want to stay short MXN peso 1*2 ratio USDMXN naked (not delta- hedged) call spreads have returned a Sharpe of 1.85 over the past 5-yrs. The trade has a large left tail risk, being exposed to large drops in the peso. USDMXN call RKOs are another expression worth considering, as they efficiently fade rich skews. The structure would benefit from well behaved and contained spot action, but most importantly it carries well defined downside risk (namely, the premium paid). 

Buy 2M USDMXN RKO call (20.70/22.00 strike/barrier) for 40bps USD (after 2% stealth), spot ref 20.1928 levels. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly EUR is inching at 37 (which is bullish), USD spot index is flashing at -16 levels (which is mildly bearish), while articulating (at 11:33 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex

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