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In addition to a more sanguine Fed outlook, a second factor that has weighed on vols recently is that day-weights for French elections have compressed sharply over the three weeks. EUR/G10 forward vols spanning both rounds of the election have fallen 3.8 % pts. on average (refer above chart), with the biggest declines concentrated in the most event sensitive pairs such as EURCHF and EURJPY (refer above chart).
This is reasonable since the odds of a Macron victory have risen in recent days. Polls on the first round of the French election are showing a solid lead for Le Pen and Macron over the rest of the field, with Macron now catching up to Le Pen; the second round Macron – Le Pen spread remains solidly 20%+ in favor of the former.
This is a film we have seen before with both the Brexit referendum and the US elections, when markets swung decisively one-way to de-price event risks only to have to hurriedly change course in a matter of days when the narrative changed. Without any crystal ball into the future, this strikes us as a set-up where risk-reward is favourable for a second look at pre-vs.
Post-event calendar spreads, especially on the flattest vol curves with the least day-weights even if they are outside the closely watched European bloc of currencies.
USDTWD satisfies this requirement: (a) the term structure of FVA strikes in TWD is out of kilter with the general pattern of a sharp election related jump from 1M ATM to 1M1M forward vol on most curves (refer above chart).
This is a function of our FVA pricer stripping out volatility of forward points from the implied vol surface, but the oddity of this set-up highlights that the 2M-1M ATM slope is one of the lowest and factors in minimal event risk. TWD realized vols have been tepid lately; underperforming implieds by 1-1.5 vols, so selling shorter-dated options in calendar spreads has merit.
Finally, TWD flies are historically depressed, hence the calendars are well constructed in short 1M straddle vs. long 2M 25D strangle format.
