Medium Term Try Hedging Drivers:

As crude sensing strength at current WTI prices at $40 a barel, a potential higher oil prices would put renewed pressure on the current account.

Uncertainty about Turkish cross-border military operations, current geopolitical risks and volatile FX inflows could fuel a deterioration in sentiment.

Further dovishness by major central banks is a strong upside risk for our TRY forecasts.

Geopolitical risks could depress the Turkish economy on the back of Russia’s sanctions.

Hedging Strategies of USD/TRY:

Contemplating above hedging drivers, we would like to advocate debit put spread. So, go long in 1M ATM -0.49 delta put option while shorting 2W (1.5%) Out of the money put with positive theta or closer to zero for time decay advantage on shorter tenors on short side.

But in long term, hedge idiosyncratic TRY risk using calendar USD call spreads as the currency has been a beneficiary of a weak dollar tide that has lifted all EM boats, it is certainly not a currency our EM team favors playing from the long side, and spot is reaching interesting levels to re-set USD longs. A steep vol curve in TRY provides opportunities to do so via calendar USD call spreads.

The macro case for a bearish directional stance on TRY rests on a number of local factors that can well trump the weak dollar wave: the lira remains beset by geopolitical tensions, inflationary pressures, CBRT policy risks and depleting FX reserves, some of which are likely to come to a head over the next couple of months.

The precise expression of a bearish view is a bit of a challenge, since high negative carry and vol levels impede standard directional option constructs. A steep vol curve comes in handy here, as one can spread the two legs of a standard call spread across two maturities to create calendar USD call spreads (e.g. buying 6M USD calls vs. selling 1Y lower delta USD calls) that materially cheapen up outright USD calls.

Their advantage over conventional USD call spreads (both strikes same tenor) is in the extent of cheapening: given the current steepness of the vol curve, the static roll down/slide of the back leg of a calendar call spread handsomely exceeds the premium received by selling an equivalent OTM strike in a standard USD call spread.