We’ve already highlighted in our recent write ups on richness in EURJPY skews.

For more reading on EURJPY IV skews, please follow below web links:

http://www.econotimes.com/FxWirePro-Whats-buzzing-in-EUR-JPY-IVs-Smart-trades-to-short-rich-skews-480334

Accordingly, we had also advocated directional trades: Buy EURJPY 6m topside seagull strikes 114/123.5/128 Zero cost (indicative offer, spot ref: 122.59).

This was advocated coupling with reasonable trade risks: unlimited below 114, the structure is buying a standard call spread strikes 123.5/118 fully financed by selling a put strike 114. As such, investors face unlimited downside risk at the expiry if EURJPY trades below 114.

For now, please be noted that the OTC indications of 1-3m combinations are the most conducive for the construction of put ratio back spreads.

Because the risks reversal bidding for higher prices in underlying EURJPY spot FX with downside risks in long run (3m RR). 1m IVs are shrinking away while 3m IVs rising, we interpret this as the options with a higher IV cost more. This is intuitive due to the higher likelihood of the market ‘swinging’ in your favor. If IV increases and you are holding an option, this is good. Unfortunately, if you have sold an option, it is bad. A seller wants IV to fall so the premium falls. You should also note short-dated options are less sensitive to IV, while long-dated are more sensitive.

Traders tend to view the put ratio back spreads as a bear strategy because it employs puts. However, it is actually a volatility strategy.

So entering the position when implied volatility is high and waiting for the inevitable adjustment is a smart approach, regardless of the direction of price movement. Based on volatility and time decay, the strategy is a “price neutral” approach to options, and one that makes a lot of sense.

Hence, one could write 1m ITM put options, while adding longs in 3m ATM or OTM put options simultaneously.