FxWirePro: EUR/GBP ATM puts seem costlier as disparity exists between IVs and premiums – option arbitrage an alternative

As expected the MPC members again voted 8-1 for keeping the rates unchanged and unanimously to maintain the stock of purchased assets at the 9 December MPC meeting.

This was the fifth time in row that the MPC member Ian McCafferty preferred an increase in the bank rate by 25 basis points.

From the diagram, one can understand while comparing the drastic difference in options premium with implied volatility and market sentiments we think the hedging cost would not be economical for downside risks upon deploying ATM instruments.

The implied volatility of ATM contracts for near month expiries of this the pair is at around 8.5%.

NPV of ATM put - 313.60 while Premiums trading above 21.88% at GBP 382.27 for lot size 100,000 units.

So alternatively, here comes the arbitrage strategy in which options trading that can be performed for a riskless profit as EURGBP ATM puts options are overpriced relative to the underlying exchange rate of EURGBP.

To perform this conversion, the hedger should short underlying spot FX and offset it with an equivalent synthetic long put (i.e. long ATM +0.51 delta call + existing short spot FX) position.Profit is locked in immediately when the conversion is done, the profit would be Shorting Selling Price - Price of Underlying spot FX - Initial Premium Paid.