FxWirePro: BoJ’s shift in monetary policy stance - A run through on USD/JPY put spread structure

Today, the Bank of Japan (BoJ) confirmed last week’s rumours and tweaked by announcing a shift to the range of assets it would buy as the form of its yield curve control strategy and introduces extensive "forward guidance" committing to low rates for a prolonged period of time. It would now allow larger volatility of the 10y yield around its 0% target, while it still plans to counteract excessively rapid increases in the yields. However, the market reaction to last week’s media reports probably showed the central bankers that this adjustment left alone would result in an appreciation of the yen. 

USDJPY tend to plunge during summer vacation season ("Obon" in the Japanese language which is in mid-August). Such seasonality is not strong, but USDJPY now has a tendency to decline for the first 10 days of August. Especially in the past 5 years since Abenomics started, the pair dropped during the first 10 days of August four times out of five.

Off spot reference: 111.51, buy a 1M 110.25/109 put spread for 36 bps net premium indicatively (vols 7.4/7.6 vs 8.05 choice).

The maximum payout is 115bp, max payout/cost ratio is 3.2, and the put spread is 53% discounted to a standalone 1M 110.25 USD put/JPY call.

The rationale for the put spread structure is two-fold:

a) It takes advantage of the recent widening of short-dated risk reversals in favour of JPY calls to reasonably stretched levels adjusted for the level of ATM vol (refer above chart).

USDJPY 1M 25D risk-reversals currently imply a spot-vol correlation level of around -38%4, which is not a historically high bar for realized spot-vol correlation to beat but is nonetheless expensive vis-à-vis recent delivered numbers (2-wk +25%, 1m +10%) and supportive of skew selling option structures such as put spreads; and

b) The extent of any potential yen strength from here is likely to be capped in the fundamental view, specifically after the knee-jerk decline in USDJPY spot late last week. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly JPY spot index is flashing at -111 levels (which is bearish), while hourly USD spot index was at -109 (bearish) while articulating at (12:52 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex