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In this write-up, we emphasize that the Eurozone political risks hovering in the months to come while formulating hedging framework of EURAUD.
Technically, the pair has been in the phase of consolidation mode since February 2017. For more reading, refer below weblink:
Well, the bullish approach of euro has performed considerably so far, but for now, a little caution is added as it is heading towards channel resistance. The recent political developments in the Euro area have garnered attention. In Spain, the acrimonious standoff between the central and Catalan government has intensified uncertainty following the illegal referendum in which 90% of the voters voted for independence, resulted in a 20bp widening in Spain-Germany yield spreads intra-month.
In Germany, even though Merkel won the fourth term as Chancellor, CDU/CSU and SPD suffered large losses while the right-wing AfD populist gained.
However, we do not anticipate these political events to be a durable driver of euro valuations. While uncertainty in Spain has indeed increased after the referendum, these developments remain more relevant for domestic policy rather than the Euro area as a whole and thus have had limited impact on markets thus far.
OTC Outlook and Options Strategy: In the case of optionality, the skews of 2m implied volatilities are projected to spike above the current realizes, positively skewed IVs indicate bidding for hedging upside risks in the underlying spot.
Thus, contemplating all the above underlying factors of EURAUD, we like being short vol in short run, selling that premium conditionally on a pay-off benefiting from higher strikes.
Prefer a ladder to a call spread ratio As we expect limited spot appreciation and topside volatility, we recommend buying a diagonal call ladder. Buy 2m ITM Call, simultaneously stay short in 1 lot of 1m ATM Call and Sell 1 OTM Call of positive thetas (strikes 1.4750/spot/1.55).
That structure improves the odds compared to a call spread ratio as the maximum and constant profit zone is reached over a range instead of a single spot level.
