FxVolWeekly
26 - Nov - 2021
Short-Dated IV/AV Spreads
G-10 FX implied vol has been approx 50-55 pct below its long term historical norms for some time. Whether we are now emerging for that low vol regime is now key. Any short vol trade in this context is a bet against a continuation of the current trends (or at least a bet in favour of a sharp deceleraton). This is particularly true in those FX pairs that exhibit a large degree of spot vol correlation, for example, CADJPY and USDJPY in particular. Both FX pairs are showing up as expensive on our percentile rank indicator but as you can see from the chart above USDJPY stands out as particularly expensive vs the running actuals. Of course, if the world is about to be plunged into another global lockdown then these fine distinctions are somewhat irrelevant. So in a sense, any short-dated short vol trade constructed with a limited loss profile will almost have to be at the same time a bet that the current premiums will fall but also that last week's sudden moves will to some extent not be further extended. Bearing this in mind we will look at not only the USDJPY and JPY crosses both in terms of the percentile rank indicators and IV/AV indicators but also the size of the spread between Friday's closing vols and the rolling actuals. The odds are that the moves are overdone and some sort of price retracement is in order. In any event, it will take more ongoing scientific investigation to know with any certainty the degree and severity of the latest Covid strain.
While the front end of the EURCAD curve is close or closer to fair value compared to other FX pairs the back end now looks sufficiently overpriced to warrant a long term butterfly or condor trade. This makes sense as well given the relative cheapness of the longer-dated EUR call skew. A +1.4500-(2X)1.5000-(+)1.5500 EURCAD butterfly would make sense in this context or a condor structure (+1.45;-1.48;-1.51;+1.54).
No sign yet of any meaningful bottom indication in EURCHF with our daily dispersion indicator breaking out to new highs. While USDCHF long term momentum remains positive the drift lower in EURCHF is dampening the dollar's upside vs. the Swiss franc and we may have to see a bottom in EURCHF before we see any chance that the previous import 94.50 level is taken out in USDCHF.
The EURCHF long term momentum chart remains very bearish with the break of 1.05. While EURCHF vols have risen they are not that much higher on the week and the risk reversal are also largely unchanged. Our takeaway is that while EURCHF remains under pressure it is not seen close to some sort of dramatic further decline.
While one and two weeks AUD implied vols broke the 10% level on Friday the one month closed just under 10%. As you can see from the chart the AUD is just barely holding an important support line while the spread vs the actuals has widened.
EUR risk reversal moved better bid for EUR calls on Friday but the skew is still bid over for puts. The skew reached a new cyclical low in line with the spot move lower and that does not imply the kind of divergence that we would normally associate with an important bottom. Ideally, the EUR bottom would be signalled by the skew bottoming and turning up ahead of a new spot low. The odds are that further EUR weakness is likely.
The dollar rally has fueled a sharp up-tick in MXN implied vols and the 3M vs 6M spread is now starting to look attractive for one of our favour calendar spreads. Taking into account the vol spread, the skew that is bid for MXN puts over, and the interest rate differential MXN call calendar spreads are starting to look interesting. We would look to sell the 3-month MXN out of the money calls and buy the same strike for 6-month maturity.
It is difficult not to come to the conclusion that the FX markets have discounted an abundance of bad news with respect to the latest Cov19 mutation. We will likely not know for two weeks the extent to which this changes the overall narrative. Two-week yen actuals ended the week at 7.3 with the implied vol ended at close to 10%. The one month yen implied vol closed the week at just under 9% with the 4-week actual at 6.5%. Yen risk reversals also moved sharply lower. The one week Yen risk reversal ended the week at nearly 1.5Vols bid over for yen calls. This move also looks overdone and is due for a correction next week.
FxVolResearch Ltd operates under an exemption order issued in 2003 by the BCSC. The material in this report is intended for accredited investors or professional FX risk managers, traders, portfolio managers who are familiar with and knowledgeable of FX derivatives, and understand the potential risks inherent in options trading. The material in this report cannot be reproduced or re-transmitted in any format without our expressed consent. 
Research Director