FxWirePro: Long USD/CHF Call Butterfly Spreads Best Suitable on Sluggish IVs and Well-Balanced Skews

We have upgraded the risk bias around the forecasts from CHF negative to neutral. The pair (USDCHF) has been oscillating between 1.0060 – 0.9560 levels from the last couple of months. This long-lasting tight range-bounded major trend likely to prolong further.

OTC Updates and Options Strategy: 

Amid the tepid underlying spot FX movements, let’s just quickly glance through above-implied volatility (IV) nutshell before deep diving into the strategic frameworks of USDCHF. CHF crosses are showing the least IVs among G10 FX bloc (1m IVs are at 5.65 and 4.48 for USDCHF and EURCHF respectively).

IV factor is highly imperative in FX option dynamics because the option pricing significantly depends on future volatility. 

Ascertaining future volatility accurately is almost impossible for any FX veteran. Nevertheless, computing the marketplace’s expected future volatility is quite feasible using the option’s price itself which is known as implied volatility (IV). 

The execution of options trading strategy: Contemplating above rationale, the recommendation would be on buying (2w) OTM 0.39 delta call while simultaneously shorting ATM call with similar expiries and buy ITM 0.79 delta call while simultaneously shorting an ATM call with similar expiries. 

The rationale: The positively skewed IVs of 2w tenors are stretched on either side, and the underlying spot movement is wedged in a tight range. 

Contemplating the above factors, this strategy is structured for a larger probability of earning smaller profitability but certain profit as USDCHF is perceived to have low volatility.

The highest return for this strategy is achievable when the pair at expiration is equal to the strike price at which the call and put options are sold. At this price, all the options expire worthless and the options trader gets to keep the entire net credit received when entering the trade as profit.

Risk/Returns Profile: The maximum return occurs at ATM strike. A smaller return is made between ATM strikes and the break-even points. The maximum loss is limited by OTM strike prices.

Effect of Volatility: The value of the options will decrease as volatility decreases, which is usually conducive for the strategy. An increase in volatility will be generally bad for the strategy as stated above.

Effect of Time decay: The value of the option decays as each day passes (good). Courtesy: Sentrix & Saxo

Currency Strength Index: FxWirePro's hourly USD spot index is inching towards -9 levels (which is neutral), while hourly CHF spot index was at -88 (bearish), while articulating (at 11:47 GMT).

For more details on the index, please refer below weblink:

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