FxWirePro: EUR/AUD vega put ratio spread to tackle high IV

The uptrend that has been gradually prolonging from last three months has taken one step ahead to break trendline resistance; the pair has now taken a trendline support exactly at 1.5598 which we had earlier anticipated. It looks like this currency cross has set up a new stage for its bull run as you can make out from strong bull candles with all leading technical oscillators are positively converging and lagging indicator to justify this in medium term.

Why ratio spread: This is an income strategy. You are looking for a net credit if the stock stays within a range or rises. Current IV of ATM contracts of this pair is that 15.42%, An increase in implied volatility, all other things equal, will have a negative impact on this strategy. The combined Vega of the two short puts will generally be greater than that of the single long put. However, the extent to which the options are in-the-money or out-of-the-money, the time to expiration and level of interest rates are all factors that influence options' sensitivity to changes in market volatility, so the investor would be well-advised to test out any strategy using a theoretical model before actually executing a trade.

Execution: EURAUD is currently trading at 1.5887. Short two lots of next month OTM strike puts. Buy one deep OTM strike put of the same expiry.

Advantage: This position will be profitable if the EURAUD stays within a range. And 2 short sides go worthless due to time decay and best suitable during high implied volatility times. The passage of time, all other things remain equal, will generally have a positive impact on this strategy.

Risk/Reward Profile: There is unlimited risk in this position, with capped reward. Early assignment, while possible at any time, generally occurs only when a put goes deep in-the-money. The maximum loss would occur should the pair becomes worthless.