FxWirePro: Aussie Consolidation Prolongs Amid Looming Headwinds of Covid-Pandemic – OTC Updates & Options Strategy

AUD’s rally to above 0.72 in August coincided with the MSCI World index reaching highs since Feb, maintaining the Aussie’s traditional positive correlation with risk appetite. The Aussie’s support is broader than equities however, with commodity prices accelerating in recent weeks, especially iron ore, copper and gold. Westpac’s index of Australia’s commodity export prices is up 32% since late April, reinforcing the current account surplus. Australia’s renewed Covid-19 containment challenge is a potential brake on gains, however.

AUD has continued to rally over the past month and briefly broke through 0.72, the highest level since early 2019 (refer 1st chart). Drivers of the rally are unchanged from recent months, with a combination of leverage to risk markets/bearish USD expressions, and more idiosyncratically, strength in iron ore prices exerting upward pressure. The recent outperformance of the exchange rate, alongside upward revisions to the iron ore price outlook by J.P. Morgan commodity analysts deliver near term upside risks to our AUD forecasts. Still, resumption of COVID-19 cases and a stalling in the national economic recovery keep us cautious. We forecast a decline to 0.66 at Dec-20.

Quick run through on OTC updates & options strategy:

Considering all the above factors, we could foresee the rosy times for the OTM overpriced put writing, accordingly, diagonal debit put spreads have been advocated so as to mitigate the potential downside risks with a reduced cost of trading.

The rationale: The positively skewed IVs of 3m tenors are in line with the bearish expectations, they still signify the hedgers’ interests to bid OTM put strikes up to 0.69 levels (refer 2nd chart).

While we see fresh positive bids for the existing bearish risk reversal (RRs) setup across all the longer tenors (refer 3rd chart).

In a nutshell, AUD OTC hedgers’ sentiments substantiate that their risk mitigating activities for the further downside potential has been clear amid minor upswing expectations.

The execution: The above options strategy reads this way, short 2w (1%) OTM put option with positive theta (position functioned as per the expectations as the underlying spot has rallied considerably), simultaneously, add long in 2 lots of delta long in 3m (1%) ITM -0.79 delta put options. We keep reiterating that the deep in the money put option with a very strong delta will move in tandem with the underlying spot FX. Courtesy: Sentry, Westpac & Saxo