FxWirePro: Strength of Korean Won Seems Diverging From Underlying Factors – Deploy USD/KRW Call Calendar Spreads

The lower USDCNH levels on the prospects of a partial US-China trade deal is to be credited for the recent Korean Won’s outperformance. While we are cautious though about adding fresh directional shorts in the won at current levels. 

KRW strength is closely watching the US trade balance. The press is turning yesterday’s data into a veritable collapse of US imports from China. The data is much less spectacular, but clear-cut: US imports from China are falling very clearly. What is more important for the dollar though: there is no sign of a de-globalisation of the US. If one also looks at the - increasingly important - service sector it becomes clear that the trend of rising US imports continues unabated.

The USDKRW sentiment gauge is still above previous trough points, whilst our broader EM FX risk appetite index is not yet at levels where it typically mean reverts. Equity inflows can also be boosted by the better tech cycle dynamics.

The cheap-but-not-cheap-enough view on USDKRW makes it difficult to propose high conviction delta-one trades at this juncture, the set-up is near-ideal for premium-earning option overlays on existing cash won shorts.

Crucially, the won’s current cyclical misalignment dovetails well with our proposed structure – short front (3M) vs. long back (6M). 

USD call calendar spreads: The net positive theta profile of the calendar spread is consistent with that view, the run-up to the Phase I US/China trade deal is likely to be more reliably characterized by lower FX volatility than a full-throated embrace of carry trades, and allows us to better wear the long TWD/KRW cash position in the EM Asia portfolio that is bleeding negative carry at the current levels of FX implied yields.

On this basis, we advocate the following option structure: Off spot reference 1165.50, sell 3M 1200 strike USD call/KRW put one-touch option vs. buy 6M 1200 strike USD call/KRW put one-touch option, equal USD notionals for net 14% USD (individual legs 32.6% vs. 46.6% indic.). The net premium of 14% rolls up to 32.6% in 3-month time (2.3x carry gearing) if spot, forwards and vols were to remain unchanged. Courtesy: JPM