RBA outlook:

We add a paid October RBA OIS trade at 1.52%. Australian rates markets are increasingly pricing in a weak Q2 CPI result next week.

While our expectation is for a low underlying CPI print (ANZ: 0.4% q/q, mkt: 0.4% q/q) and we also expect a subsequent August rate cut, we see a short in October as cheap insurance against an upside CPI surprise.

We pay October at 1.52% with a view that even with a 25bp cut in August; we would be limited to a 2bp loss at the October maturity unless the RBA was to cut by more than 25bp

Hedging Framework:

Since the pair has been struggling at resistances of 1.0750 levels, additionally the Chinese slowdown should continue to resonate AUD in the long run.

For now, if you compare the 1W ATM IVs with the option premiums of the same tenor we find the huge disparity between them and the downswings in underlying spot FX are most likely, the prevailing bullish swings may not be having the strong momentum in rallies.

From above sensitivity table, one can see 1W ATM implied volatilities of this pair is just shy above 9%.

Whereas the premiums of ATM premiums of the same tenors are trading over 30% more that of Net Present Value. Thus, there exists a huge disparity between the pricing of the options and signals offered by OTC FX market of AUDNZD.

Hence, we could utilize this as opportunities for shorting overpriced calls in order to reduce the long-term hedging cost of long positions in call options.

Subsequently, we recommend initiating more shorts in put back spreads (3:2) 1W (1%) ITM put, and simultaneously longs in 2 lots of 1M ATM puts and 1 lot of (1%) OTM put with the same expiry, thereby the strategy is to be executed at net debit but at reduced cost.

Please be noted that the tenors selected in the diagram are just for the demonstration purpose, use accurate tenors as stated above.