Weekly FX Review
23 -June - 2017
With Canada's inflation numbers coming in under expectations on Friday and oil finding limited support over $43, the market is assuming that the pressure on the C$ shorts to unwind their extended positions has passed and the correction danger has passed it's peak. While this may prove true over the longer term,  there are some reasons for caution, given that we have not yet seen a complete wash out in the short positions according to the COT report. Granted the level of shorts has declined but still remain historically elevated. Secondly and more to my point is the chart above which shows the short term correlation of one month implied vol and spot. While not the most consistent and reliable indicator, as it can be early at times, it does suggest that more C$ upside is likely. While we largely subscribe to a bearish C$ view over the longer term, the position is likely to be the main driver in the near term. And while short term  vols  have moved higher, tested and failed to break 6% in the 3mos,  vols  are very likely to be under pressure once again in the near term. 

 CADJPY which generated some long signals last week using Vortex, are now fading fast and are very close to reversing down. As you can see from the chart CADJPY is just holding the hourly trend line. The upside trend for now may be exhausted. 
 GBPYEN may be taking out it hourly trend line. Momentum is nearly back to par. 

 EURJPY is likely to start to trend soon following a dull period of consolidation. Asumng the EUR continues to lose topside momentum and the same is true of Dollar Yen the likely near term  direction is down. 


EURGBP continues to see top side momentum divergence. This increases the likelihood of a larger correction. Positioning may well be excesively long. Longer term EURGP risk reversals continue to creep higher for EUR calls. 
The FX market is getting so unexciting that short-term options and vols are making new lows for the year. While buying short-term options is generally not a productive trade the balance of probabilities is now starting to favor the long side; even if you buy short-dated strangles. AUD stands out as being particularly inexpensive in both the one and two week periods.  These kinds of short-dated trades are sometimes referred to as expiration back spreads. You are taking a view on to what extent the option will end up in-the-money at expiration.  If implemented on a  delta neutral basis with straddles then you will likely want to re-balance over the life of the option, more so in the two week period than in the one week. But the same kind of expiration bet can be leveraged through the purchase of short-dated strangles.  Since the probability of say a 25 delta strangle ending up in the money is lower than the straddle they nevertheless, at these vol levels can be part of a profitable long-term speculative trading strategy.  Even with statistical odds in your favour and a clearly defined edge, the strangle will likely end up out of the money and worth zero in the majority of cases. So why do this trade? The reason in simple terms is that the rewards of being right, far exceed the risks associated with being wrong. You can do this trade a dozen times and lose money on 75% of them and still make more money on the remaining 25% because the payoff from winning trades greatly exceeding the cost of the bet.  Having said that though, this is a strategy that is likely to have a low % success rate and for that reason, a smaller amount of capital-at-risk should be allocated to exploit it. In the premium edition of the FxVolWeekly, we will identify these trades and suggest specific strategies exploit this on-going phenomenon & market inefficiency. Lastly, when these opportunities arise, often all that is required is a mid-market bid to own them as the market is usually excessively long and looking to give any decent bid.

The chart above shows AUD actuals nearly the most recent cyclical lows which serves to reinforce the buying short term options arguement made above. When short term options get this cheap return profile becomes even more assymetrical: upside potential gains far exceeds downside risk. 

Short term yen is also cheap but not quite as inexpensive as short term AUD but still close to making new lows for the year. 

EURCHF actuals also trending lower as the CHF is slowly grinds higher vs the EUR. Take note of the double top in the spot chart. 


 EUR and CHF short dates options are also near their lows for the year. Short-dated vol is not as cheap as AUD because the IV-AV spreads at still positive. 

Similar chart with EUR actuals approaching their most recent lows. The downside is limited for further falls in near-dated vol, and while the implied vols are slightly higher they too are close to cyclical lows. The odds here  favour  long option trades, which includes short-dated strategies described above, as well as short term option-based insurance strategies designed to hedge a spot exposure or a near term FX payment commitment. 



AUD risk reversals moved back better bid for puts over the week, particularly so in the 3Mos period. While short dated AUD vols remain offered, the mid part of the curve 3M on out moved slightly better bid. This is consistent with the view that market makers are selling the short dates to fund their long positions in the body of the curve. 



Links to previous FxWeekly

Best Regards, 
James Rider

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