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We maintain a constructive view on RUB among EMFX strategy and especially so against ZAR. The idiosyncratic nature of RUB, other than via the skew premium highlighted above, is also reflected by the low-beta to vol ratios of 1st chart, which essentially stresses how RUB vol pricing is mostly driven by local than exogenous factors (we recall that oil is not included amongst the global factors we monitor). These results are broadly consistent with an analysis of EM macro vulnerabilities, which fins Russia near the bottom of the countries examined. With fundamentals (most notably, a currency which remains undervalued) still supportive, and diminished downside risk to lower oil prices, there is potential in fading the rich skew premium highlighted above.
The performance of short skew on USDRUB (trading daily 3m 25-delta riskies, delta hedged with smile- adjusted forwards) has been attractive since Spring 2018, at least by neglecting the impact of trading costs.
Sell delta-hedged 3m 25-delta risk-reversal on USDRUB at 2.05/2.35 vols indic.
The 2nd chart displays a long term back test of systematically running 1*N ratio call spreads (vega notionals) in USDRUB. The1*2 ratio call spread structures are efficient in capturing skew underperformance during risk supportive times but are exposed to blow-ups (left tail risk). The LHS chart shows systematically strong performance outside of the devaluation and sanctions left tail episodes. N=2. i.e. 1*2 vega notionals structure is a sweet spot in maximizing the long term Sharpe while keeping net short vol in check. With the supportive macro for RUB and an attractive vol-beta-skew setup at the moment we see RUB as an attractive pocket where one can pick up theta income.
While aside from the global recession apprehensions and higher risk aversion, the South African rand is particularly impacted by Moody's' upcoming rating review at the beginning of November. We have assumed that South Africa will be able to maintain its sovereign credit rating for the time being. A downgrade to junk could trigger a significant ZAR depreciation. Thus, over the short term, this is where we see the biggest risks to our forecasts.
Consider: 3M delta-hedged USDRUB 1*2 ratio call spread (ATM/25D) in vega notionals @9.65ch against @10.9/11.3 indicative.
Alternatively consider a RUB – ZAR RV trade, supported by the earlier screener on skews:
¾ Sell 3M delta-hedged USDRUB 25D call @10.9/11.3 and hedge it with 3M delta-hedged USDZAR 25D call @16.325/16.725, equal vega. Courtesy: JPM