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Since the Brexit referendum and the 2016 US election, the two major upsets during the turbulent 2016, FX option markets have been sensitive on the issue of political event risk premium. The upcoming 2020 US election pricing are gearing to be one of the most eventful in history and as one possible driver capable of breaking the fragile state that global economy lies in at the moment.
We referred to the JP Morgan’s newly introduced scorecard for selecting the best FX hedging instruments, for different currencies and over time. Skipping all technical details, the idea behind the model was just to highlight how different instruments could perform based on the relative interplay of different pricing parameters, allowing an optimal allocation as a function of time. The note has attracted the interest of several real money players, especially in the EUR-area, looking for viable solutions at a time when elevated (although slightly declining vs. Q4 2018) fwd points and flat yield curves implied heavy costs if implementing hedges via forwards.
We refer to the earlier piece for a more comprehensive review of the approach. The recent flip in the sign of the riskies cut the weight associated with riskies based on the rules of the scorecard. For GBPUSD risk-reversals get the highest allocation (41.7%) given the negative skew.
At present, the scorecard approach (refer above nutshell) favours call spreads (16.7% on average) and seagulls (20.8%) over forwards (20.8%) and risk-reversals (41.7%).
On GBPUSD upside, the JP Morgan’s scorecard approach has also largely outperformed the benchmark forward since 2014.
Forward points remain a factor impacting long forward positions, although less harmful than for EURUSD given the tighter carry.
Momentum has recently waned on GBP, with price remaining in a tight range over the past few weeks.
Sign of the skew well in negative territory favours “bullish” (i.e. long GBP calls and short GBP puts) risk- reversals over spread structures for playing GBP strength over medium horizons:
Sell 6m 25-delta risk-reversal (sell GBP put, buy GBP call) on GBPUSD at 1.3/1.6 vols indicative. Courtesy: JPM
