FxWirePro: Upholding longs in USD/RUB via call spreads seems good hedge for portfolio with high yielder exposure

Option Trade Strategy: Buy 3m USDRUB call strike 59, Sell call strike 62 knock-in 65 Indicative offer: 1.23% (vs 1.06% for the vanilla call spread, spot ref: 56.50) The position entails buying a USDRUB 3m call strike 59 financed by a call strike 62, with a topside knock-in at 65 only on this short leg.

Rationale: Beware a RUB correction Are you concerned that RUB positioning is too heavy, stagnant price action is a warning sign, fundamentals could turn, and a significant correction could happen? We are. On 31 May, we recommended going long USDRUB as the ruble had approached the tipping point, looking for a move to 61.30 in the next three months, based on domestic factors. 

Key drivers of our bearish RUB view: We turn bearish in RUB on the concern of commodity headwind and seasonally weaker current account outlook over the summer. We are more cautious of the commodity exporter, as terms of trade are unlikely to be favorable for RUB as oil prices remain weak. Together with any potential return of generalized financial market volatility in the coming months, the effect will manifest itself in heightened volatility of RUB. We recommend buying RUB vol via call options. Directionally, we think RUB is vulnerable to weakening over the summer as the current account seasonally deteriorates. Being long USDRUB is a good hedge for a portfolio with high yielder exposure.

This structure offers potential extra gains compared to the vanilla call spread capped at 62, as the pay-off captures upside up to 65. In the event of a move beyond this barrier, the maximum gain is the same as for a vanilla call spread. Our appearing call spread costs only 17bp more than a vanilla proposal, but it potentially hedges twice as much RUB downside (about 10% instead of 5%), providing additional exposure at minimal cost.

Risk profile: Limited to the premium paid Below the 59 call strike, the maximum loss is limited to the premium paid.

Take advantage of high skew Negative carry is quite punitive in forwards (-75bp/month), so cost-effective option exposure is a good alternative.

Shorting the RUB in volatility space is also very expensive: implied vol is one of the highest in EM and risk reversals are the highest. The skew-to-ATM volatility ratio has been rising steadily since early 2016, likely related to investors hedging bullish RUB price action. These volatility parameters favor structures that sell topside skew to cheapen up bullish USDRUB exposure.