FxWirePro: Aussie Hedging Perspectives Amid Bolstering Global Risk Appetite

We expect two further RBA rate cuts, in February and again by June, taking the cash target to 0.25%, followed by a small but open-ended ACGB purchase program.

AUDUSD has been sliding with an intensified selling momentum from the highs of 0.6928 levels to the current 0.6775, the downswings have halted at 0.6755 levels.

The medium-term perspectives: The Aussie has bounced around 2 cents since early October, aided by a more positive tone on US-China trade talks and the unexpected Brexit breakthrough which has bolstered global risk appetite. 

Aussie should remain supported near term but any trade in the 0.6950/0.7000 area is likely to attract substantial sellers.

While supply interruptions could limit the recent fall in iron ore prices, coal prices remain near 3-year lows and we expect the US and China to reach only a very limited trade agreement in coming weeks.

Moreover, the RBA does not want to encourage an A$ revival and pricing for another rate cut has been unwound too far, as we still expect a rate cut in Feb 2020. Our year-end target remains 0.6700 levels.

Ahead of RBA’s monetary policy scheduled for this week, the OTC outlook of AUDUSD are useful for the options strategic framework.

Please be noted that the positively skewed IVs of 6m tenors still signify the hedgers’ interests to bid OTM put strikes up to 0.65 levels which is still in line with the above bearish projections (refer 1st nutshell). 

Please also be noted that bearish risk reversals (RRs) across all the longer tenors are also in sync with the bearish scenarios amid momentary shift in mild upside risks (refer 2nd (RR) nutshell).

In a nutshell, AUD OTC hedgers’ sentiments substantiate that their risk mitigating activities for the downside risks has been clear. 

The combination of AUDUSD’s short-term potential to spike above and the lower IVs is luring for the OTM put options writers. While the medium-term perspective is attractive for bearish hedges via ITM puts.

Accordingly, diagonal put spreads are advocated to mitigate the downside risks with a reduced cost of trading.

The execution of options strategy: Short 2w (1%) OTM put option with positive theta (position seems good even if the underlying spot goes either sideways or spikes mildly), simultaneously, add long in 2 lots of delta long in 3m (1%) ITM -0.79 delta put options. 

The rationale: Bidding above 6m IV skews, we have advocated delta long puts for the long term on hedging grounds, comprising of more number of ITM long instruments and theta shorts with narrowed tenors for 1m lower IVs to optimize the strategy.

Bearish outlook with rising volatility good for the option holder. While put writers would be on upper hand on theta shorts in OTM put options that would go worthless on lower IVs as the underlying spot FX keeps rising,. Thereby, the premiums received from this leg would be sure profit. We keep reiterating that the deep in the money put option with a very strong delta will move in tandem with the underlying.

Alternatively, on hedging grounds we advocated shorting futures contracts of mid-month tenors, we wish to uphold the same strategy as the underlying spot FX likely to target southwards below 0.65 levels in the medium run. Writers in a futures contract are expected to maintain margins in order to open and maintain a short futures position. Courtesy: Sentrix, Westpac and Saxobank