FxWirePro: Prefer AUD/JPY vega puts on long leg on 1w ATM IVs - rallies and HY vols likely to bolster PRBS yields

This pair has dropped below DMAs as selling momentum seems to have been intensified but long-term downtrend remains intact upon the convincing volumes and other technical indicators favouring bears long term charts.

While yen crosses ahead of BoJ monetary policy, the IVs of ATM contracts of 1w and 1m tenors are spiking crazily and this has been justified by historical volatilities in spot FX fluctuations (see big real body candles on monthly technical charts).

ATM IVs of 1w expiries are flashing at 24.30% and 18.22% for 1m tenor.

Traders tend to view the put ratio back spread as a bear strategy because it employs puts. However, it is actually a volatility strategy. The implied volatility of 1M ATM put contract is over 18% and it is quite higher side when long-term trend is bearish.

Options with a higher IV would cost more. This is intuitive due to the higher likelihood of the market 'swinging' in your favour. If IV increases and you are holding an option, this is good.

During such scenarios, Vega is the sensitivity of an option’s value to a change in volatility. It is usually expressed as the change in premium value per 1% change in implied volatility. Vega is generally larger in options which have longer time until expiry, and it falls as the option approaches expiry.

As we expect the underlying currency exchange rate of AUDJPY to make a larger move on the downside. As shown in the figure purchase 1M 2 lots of At-The-Money -0.52 delta puts and sell 1W one lot of (1%) In-The-Money put option.

So far we all know that the position uses long and short puts in the ratio, such as 2:1 or 3:2 and so on to maximize returns depending upon risk appetite and returns expectations.