Pick up relative value in conditional spreads, the conditional long/short vanilla spreads provide another avenue to explore when looking to fade vol risk premia. The idea is to structure zero-cost (or even premium negative) spreads of out-of-the-money vanilla options between two well-correlated pairs sharing a common pivot currency.

Opportunities arise when vols and skews in one pair diverge markedly from the other pair. Unsurprisingly, this is currently the case for MXNJPY vs other high beta JPY.

The above chart illustrates as to how the blow up in 2M MXNJPY vols and skews relative to AUDJPY is pushing the lines of isopremium strikes away from the cloud of realized spot returns. According to this picture, MXNJPY calls can be sold to fund AUDJPY calls, and as long as the implicit long AUDMXN stance isn’t upset in a dramatic fashion, the position should pick up positive theta.

Table 2 screens from a large universe of USD, EUR, JPY, GBP and AUD pairs to identify other such opportunities, applying filters on 1) 1yr realised R-Squares between 1M spot returns > 50%, 2) % of spot returns above isopremium line either > 30% or < 70%, and 3) log(Impl/Realised Beta ratio) > 0.25.

We also highlight the combinations that result in implicit cross pair stances that are consistent with our macro bias. The table ranks the combinations according to how far the % above isopremium is from the 50% mid-mark. It suggests that a vol carry efficient way to engineer a long USDCAD position is through a JPY pivot, by buying CADJPY puts funded by selling USDJPY puts.