Please be noted that the massive shrink in EURGBP implied volatility of ATM contracts across all tenors.

While the risk reversals, for now, have taken adverse directions from last 1 year’s hedging sentiments that were bidding for upside risks.

Fading towards 8% and below 10.75% for 1-3m tenors, the tepid IVs among G10 FX space despite the fact Eurozone elections are lined up appear to be conducive for call option writers as the delta risk reversals are also bidding for puts progressively with negative numbers that signify hedging arrangements for downside risks over the period of time.

While the positively skewed IVs of ATM contracts are signifying the hedgers’ interests in OTM puts that is in sync with the risk reversal indications.

Please also be noted that the options with a higher IV cost more which is why in this case OTM puts have been preferred over ATM instruments. This is intuitive due to the higher likelihood of the market ‘swinging’ in your favor. If IV increases and you are holding an option, this is good.

On the flip side, when you write an option, the seller wants IV to remain lower level or to shrink so the premium also fades away.

As shown in the above diagram, (2%) OTM calls have been overpriced 11.44% above NPV while IVs of this tenor are just shy above 9.10%.

Hence, considering above OTC market reasoning, we think downside risks are on the cards, as result we reckon deploying shorts in such exorbitant call options while initiating longs in ATM puts in our hedging strategies that seem worthwhile if you have to ponder over the payoff structure under the scenario of the underlying spot FX keeps dipping further.