FxWirePro: Luring Opportunity For Aussie Put Writers - AUD/USD OTC Outlook And Options Strategic Framework

The momentum has swung back to the upside following yesterday’s stronger-than-expected jobs data, targeting 0.6940 in the shorter run.

Q4’2019 included two key positive developments for global risk appetite – the Brexit deal breakthrough and the US-China “Phase One” trade deal. This was enough for the Aussie to reach highs since July. Domestically, Australia continues to print trade surpluses and iron ore’s 3-month highs are backed by a bounce in copper prices (coal remains a weak spot). 

Yet 0.6950 did not give way and it is easy to imagine US-led trade tensions returning in 2020. The Iron ore prices are rolling over on patchy demand and resilient supply, while we believe the US and China still have major hurdles which will keep tariffs in place.

Most importantly, we expect the RBA to lower its Australia GDP forecasts and cut the cash rate in Feb, an outcome only about 50% priced.

The Aussie should continue to meet sellers with a 0.69 handle over year-end, with risks below 0.67 on anticipation of or delivery of a Feb cut.

OTC Outlook of AUDUSD and Options Strategic Framework:

Please be noted that the positively skewed IVs of 3m tenors still signify the hedgers’ interests to bid OTM put strikes up to 0.67 levels which is still in line with the above bearish projections (refer 1st nutshell). 

Please also be noted that bearish risk reversals (RRs) across all the longer tenors are also in sync with the bearish scenarios amid momentary shift in mild upside risks (refer 2nd (RR) nutshell).

In a nutshell, AUD OTC hedgers’ sentiments substantiate that their risk mitigating activities for the downside risks has been clear. 

The combination of AUDUSD’s short-term potential to break above 0.6930 and lower IVs is luring for the OTM put options writers. While the medium-term perspective is attractive for bearish hedges via ITM puts.

The rationale: Limiting downside though, we expect the RBA to hold steady into 2020 as it remains hopeful on Australia’s growth outlook and spec short A$ positioning is substantial. Any near-term probes above 0.6900 should attract sellers, with our year-end target still 0.6700 which is sync with the IV skews. The lower IVs envirnoment (3rd nutshell) and the underlying spot FX showing minor momentary upswings are conducive for put options writers.

Accordingly, diagonal put spreads are advocated to mitigate the downside risks with a reduced cost of trading.

The execution of options strategy: Short 2w (1%) OTM put option with positive theta (position seems good even if the underlying spot goes either sideways or spikes mildly), simultaneously, add long in 2 lots of delta long in 3m (1%) ITM -0.79 delta put options. 

The rationale: Bidding above 3m IV skews, we have advocated delta long puts for the long term on hedging grounds, comprising of more number of ITM long instruments and theta shorts with narrowed tenors for 1m lower IVs to optimize the strategy.

Bearish outlook with rising volatility good for the option holder. 

While put writers would be on upper hand on theta shorts in OTM put options that would go worthless on lower IVs as the underlying spot FX keeps rising. Thereby, the premiums received from this leg would be sure profit.

We keep reiterating that the deep in the money put option with a very strong delta will move in tandem with the underlying.

Alternatively, on hedging grounds we advocate shorting futures contracts of mid-month tenors as the underlying spot FX likely to target southwards below 0.67 levels in the medium run. Writers in a futures contract are expected to maintain margins in order to open and maintain a short futures position. Courtesy: Sentrix, Westpac and Saxobank