FxWirePro: BRL delta-hedge trades to serve both hedging and trading motives

We have emphasized BRL in this write-up contemplating some key JP Morgan’s analytic efforts, skews (i.e., BRL puts vs BRL calls) currently stand as undervalued when measured against a set of different hard currencies. This generally offers margin for hedging long BRL cash positions via risk-reversals. In the next section, we will elaborate more on the trading implications of the latter opportunity.

Trade opportunity on USDBRL skews:

BRL has been one consistent standout currency on the above carry-vol metrics for assessing cheapness of skews. 

That’s further supported in 1stchart, wherein BRL is the only USD pair that checks all the boxes. Sentiment toward BRL has been largely supportive and JPM’s Latin American analysts continue to see it as a buy. That is not necessarily negative as grind lower in USDBRL is likely to lead to softer realized vol which would be supportive of the short USDBRL put leg. 

Moreover, following the latest rebound in static carry (total return from delta-hedged 3M USDBRL 25D risk reversal, assuming unchanged markets – refer 2ndchart), delta- hedging now again pays for the skew decay. 

In other words, this offers the opportunity of entering a long convexity trade for higher USDBRL and receiving a positive, albeit tiny, time decay for doing so. As we can see from the bottom chart, the actual performance of the long USDBRL risk-reversal construct has been well explained by the static, or ex-ante proxy of, carry. 

We are recommending buying a 3M USDBRL 25 delta risk-reversal, delta-hedged, @ 1.8/2.15 vols, spot ref. 3.7594. Long BRL puts / short BRL calls constructs would serve well both trading and hedging purposes. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly USD spot index is inching towards -78 levels (which is bearish), while articulating (at 13:21 GMT). 

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex