FxWirePro: Hedge Geopolitical Risks in USD/JPY on ‘Debit Put Spreads’

In recent months, JPY has been one of the outperformers. The JPY appreciation was considerable in the Q2, mainly due to deterioration in 5 risk sentiments as concerns for an escalation of trade wars between the US and China strengthened. USDJPY fell below 110-level on May 8thfor the first time since late March this year.

Given the JPY appreciation with unexpected deleveraging and some other developments discussed in the following, we are making modest -10 changes to our USDJPY forecast. 

As mentioned above, there have been some developments for the past month. The most important event was that US-China relationship deteriorated with a possible raise of US tariffs on $200bn worth of imports from China to 25% from 10%, and this led to the deterioration in risk sentiments. This was a shock to the markets as shared consensus was that their talks were making progress and they were not too far from an agreement. As a result, JPY appreciated. The sudden change in the US attitude towards China and its stronger protectionist stance suggests risks with which the US might go hard on Japan in their trade talks. The looming risks are likely to weigh on USDJPY for the next coming months. 

USDJPY OTC update and options strategy as follows: 

Please be noted that the positively skewed IVs of 3m tenors are signifying the hedging interests for the bearish risks. We see bids for OTM strikes up to 105.50 levels. This indicates hedgers’ interests in OTM put strikes, overall, put holders are on the upper hand.

While negative risk reversal numbers of USDJPY across all tenors are also substantiating downside risks amid any momentary upswings in the short-run. 

OTC positions of noteworthy size in the forex options market can stimulate the underlying forex spot rate. The spot may trend around OTM put strikes as the holders of the options will aggressively hedge the underlying delta.

Hence, at spot reference of USDJPY: 107.650 levels, we advocate buying a 2M/2w 109.732/105.50 put spread ahead of Fed and BoJ monetary policies (vols 6.61 vs 6,89 choice), wherein short leg is likely to function if the underlying spot FX keeps spiking, we would like to maintain the ITM long leg with the diagonal tenors on hedging grounds. The lower/shrinking implied volatility is good for options writer and increasing realized volatility is good for the bearish trend. Hence, the above strategy seems to be the best suitable in prevailing volatile conditions. Courtesy: JMP, Sentry & Saxo

Currency Strength Index: FxWirePro's hourly JPY spot index is flashing at -52 levels (which is bearish), while hourly USD spot index was at -6 (neutral) while articulating at (10:44 GMT).

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex