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FxWirePro- Gold Daily Outlook 
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The run-off in the Brazilian Presidential elections between the right-wing populist Jair Bolsonaro and Fernando Haddad of the Workers’ Party will take place on Sunday. In the polls Bolsonaro is leading by over 10 percentage points and it therefore seems quite likely that he will become the new President as of January. Bolsonaro’s victory is largely priced in so that BRL gains on Monday are likely to be limited. Focus will now probably rest on Bolsonaro’s appointments and the political course he is going to take, mainly as regards reforms. It is also unclear who is going to be governor of the central bank.
It is probably partially owed to the central bank that BRL was able to stand up reasonably well over the past years despite the political chaos.
The potential risk is foreseen that the relief following the run-off will soon be followed by disillusionment. It would seem that the financial markets are very optimistic regarding the new government’s willingness to implement reforms.
Therefore, we see the potential for disappointment that is likely to put pressure on BRL. We expect BRL to trade at slightly weaker levels against USD by year-end.
The eye popping 140 vol pricing of Brazil election in USDBRL overnights a few weeks ago has given way to a much more meager 2ndround O/N pricing of 53 vol currently, implying a breakeven spot move of 2% on the day.
That however masks a nearly unprecedented degree of skew embedded in the probability distribution of USDBRL post-election spot (refer 1stand 2ndchart). In order to take advantage of the surface set-up, we scour through USDBRL put spreads (refer 3rdchart) that are well positioned for the anticipated limited BRL strength while being relatively insulated from from the inevitable vol rolldown after the event.
Furthermore, adding a knockout higher in spot further cheapens the structure and fades the elevated rich risk reversal structure shown in 1stchart. 1M USDBRL 3.65/3.55 put spread with 3.75 KO costs 64/84 vs 21bp USD choice, spot ref 3.70, 35% discount to an equivalent put spread structure without KO and 60% discount to an outright vanilla.
As the likelihood of a surprise outcome is being quickly priced out of market and consensus expectations, it is worth considering positioning for a low-cost benign result via long BRL option structures that are also able to take advantage of the post-election vol rolldown.
In the past, we have highlighted a low-cost calendar spread structure that is also well suited for the current setup. The rationale for a USD put/BRL put call calendar rests on
i) the expectation that room for tactical real strength is fairly limited after the surprisingly large 11% rally since late-September, and
ii) the post-event vol rolldown will hit short tenor structure harder. The vol curve structure is advantageous with 2w USDBRL vols screening about 3vol too high relative to 1M vols (refer 4thchart).
2wk 6.65 USDBRL put (@18.95vol choice) vs long 4wk 6.65/6.55 USDBRL put spread (@16.4/17.15vol indic vs. 15.1vol choice) costs 5/13bp USD, a fraction of the premium of buying 4wk put spread outright (78bp USD), spot ref 3.7182. Courtesy: JPM
Currency Strength Index: FxWirePro's hourly USD spot index is inching towards 52 levels (which is bullish), while articulating (at 13:11GMT).
For more details on the index, please refer below weblink:
