FxWirePro: Bearish/Bullish Driving Forces of NZD/JPY, OTC Updates And Options Strategy Amid Lingering Pandemic Turmoil

Bearish NZDJPY Scenarios: 

1) Agricultural commodities are dragged lower by the fall in oil prices; 

2) Lower rates and RBNZ credit support to banks prove insufficient to stop a rise in housing arrears due to higher unemployment.

3) COVID-19 fears re-intensify significantly, leading to multiple waves of infections or Japan-specific rises in case numbers; 

4) Assessments for the prospect of a V- shaped global growth recovery are significantly tested; 

5) Trade tensions between the US and China re-intensify with negative spillovers to Japan’s supply chain.

Bullish NZDJPY Scenarios: 

1) Fiscal easing becomes large enough to remove the projected output gap for 2021, and constrain the RBNZ’s easing stance; 

2) The terms of trade prove resilient due to supply impediments in global goods trade and elevated demand for high quality food products.

3) The outlook for the global economy recovers more sharply than expected and risk sentiment firms; 

4) Momentum in JPY selling flows related to outward portfolio investments and FDI repeats on a similar exceptionally large scale as seen in 1Q’20. 

OTC Updates, Trade and Hedging Recommendations:

The positively skewed NZDJPY IVs of 3m tenors signify the downside risks, the bids for OTM put strikes up to 62 levels clearly indicates hedgers are inclined for further downside risks (refer above nutshells evidencing IV skews). The major downtrend continuation shouldn’t be panicked the broad-based bearish outlook amid minor rallies. 

Hence, it is conducive for OTM put writers capitalizing on short-term rallies so as to reduce long-leg meant for downside hedging.

The execution of strategy goes this way: Initiate longs in at the money -0.49 delta put options of 3m tenors, simultaneously, short (1%) out of the money put options of the narrowed expiry (preferably 2w tenors), the strategy is executed at net debit (activated when spot reference: 64.300 levels while articualting).

Well, a higher (absolute) Delta value is desirable on long leg in the above stated strategy. Whereas, the Theta is positive on short leg; as the time decay is good for an option writer (that’s why we’ve chosen narrowed expiry). The short side likely to reduce cost of hedging with time decay advantage on short leg, while delta longs likely to arrest potential bearish risks. 

Alternatively, shorts in the mid-month futures have been advocated with a view of arresting further downside risks. Courtesy: Sentry & JPM