FxWirePro: Indian rupee set to bounce but in snail’s pace – Deploy USD/INR RKO puts as optimized hedging to sync with suppressed RVs

The Indian rupee surged for the 3rd consecutive day. But for today, opened little flatter at 65.13 per dollar versus previous close 65.14.

The fixed income; the market is down-casted ahead of the data announcement of CPI inflation which is due in the evening today. While the sustained supply of OMO sale today and scheduled auction tomorrow should deter building of positions in the G-Sec market."

The rupee is likely to gain upside traction owing to the mounting sentiments of capital flows and the dollar is on the back foot against a basket of currencies recovering a bit after sinking to a 14-day low as investors took note of Fed members' concern over the inflation outlook stateside.

But in the USDINR pair to be range-bound within a trading range of 65-65.50 in the near term.

OTC outlook and hedging strategy:

Low realized vol and technical support suggest RKO put INR volatility lies in the low vol bucket in the EM space (3m vol is trading below 6) but realized vol has remained constantly lower than implied vol since start 2016.

The market is, therefore, pricing a premium not justified by the volatility of the FX rate. This suggests selling volatility, and our USDINR bearish view combined with a strong technical support makes an RKO put attractive.

While the skew oriented to the topside won’t provide an extra discount to the premium, such a positive skew indicates that market volatility should fall as the spot goes lower.

The execution: Buy USDINR 3m put strike 65, knock-out 63.50 Indicative offer: 0.21% (vs 0.49% for the vanilla, spot ref: 65.14).

Risks are limited to the extent of initial premium paid, the option will lose the premium paid if it doesn’t end below the strike (65) or touches the knock-out barrier (63.50) at any time during the life of the option.