FxWirePro: Snapshot of EUR/JPY Driving Forces, Capitalize on 3m OTC Indications & Stay Hedged Via Delta Instruments

Already released industrial production data for the four largest Eurozone economies showed that output in the factory sector fell sharply in December. That points to a big slide in production for the region as a whole and we look for a monthly decline of 2.1%. Euro looks to be vulnerable again as the larger-than-previously-expected fall points to downside risks for Q4 GDP growth and we think that Friday’s update will see a downside revision to no change from the initial estimate of 0.1% GDP growth. 

But one reason for the Yen’s appreciation when entering a global recession is that investors with speculative JPY short positions face increased volatility and buy back JPY to close their short positions; we note that there was a rapid reduction in speculative Yen shorts, as market recession expectations were re-aligned. From a fundamental point of view the market reaction is understandable.

Yesterday, the euro was little changed against the  majors like dollar and yen soon after statements from ECB President Lagarde and Fed Chair Powell seemed to indicate that near-term interest rate moves in either the Eurozone or the US are unlikely. However, the major downtrend of EURJPY seems to be intact amid minor upswings. Hence, it wise to capitalize on momentary rallies for fresh short hedges ahead of flurry of data streaks in eurozone, such as, German ZEW Economic Sentiment, current a/c data, German, French & composite manufacturing/service PMIs.

OTC outlook: Most importantly, the positively skewed EURJPY IVs of 3m tenors are also signifying the bearish risks in the underlying spot (refer 1st exhibit). The bids for OTM puts indicates that the hedgers expect the underlying spot FX to show further dips so that OTM instruments would expire in-the-money (bids up to 118 levels). 

To substantiate the above indications, we could see fresh positive bids in the EURJPY bearish risk reversal (RR) set-up that indicates the long-term hedging sentiments across all tenors are still substantiating bearish risks amid minor abrupt upswings in the short-term (refer 2nd exhibit). Hence, we advocate below hedging strategy contemplating the above drivers and OTC indications.

Options Strategy: Contemplating above factors and the prevailing underlying sentiments, we’ve advocated buying 3m EURJPY (1%) ITM -0.79 delta puts for aggressive bears on hedging as well as trading grounds as the mild abrupt upswings were contemplated earlier. 

Short hedge: Alternatively, ahead of above-stated data announcements that are scheduled for the next week, we advocated shorts in futures contracts of mid-month tenors with a view to arresting potential dips, since further price dips are foreseen we would like to uphold the same strategy by rolling over these contracts for March month deliveries. Source: Sentry & Saxo