FxWirePro: Cable upside potential more likely in Q1 but unwise to disregard bearish risk – Options straps for smart hedging

Even with sterling making new lows in trade-weighted terms (nominal and real), GBPUSD meandering in a 1.30-1.35 range is foreseen for most H1 of 2018.

However, a slump to GBPUSD 1.25 would require, above all else, a stronger US dollar rather than a weaker pound alone.

We think the chances of a fall that far are about 5%, whereas, by contrast, the chances of the GBPUSD reaching 1.50 are around 15%, reflecting the possibility of another election being called and speculation emerging in earnest, that the UK could see a second Brexit referendum.

That is unlikely but not impossible and not definitely priced in by the FX market.

OTC outlook and options strategy:

Let’s glance at sensitivity tool, the positive shift in risks reversals that indicate the bullish risks in underlying spot FX prices.

Positively skewed IVs of 3m tenors signifies the interests of OTM put strikes that means the ATM puts have the higher likelihood of expiring in-the-money, while balanced hedging sentiments on either side in shorter tenors that are favorable to both call and put options holders’ advantages.

Bearish neutral risk reversals indicate hedgers still bid for downside risks. ATM IVs are still stuck between 6 to 7% range for 1-3M tenors.

Hence, in order to arrest both upside risk that is lingering in intermediate trend and major declining trend, we recommend diagonal option strap strategy that favors underlying spot’s upside bias in short run and mitigates bearish risks in the medium term.

So, we recommend building the FX portfolio exposed to this pair with longs positions in 2 lots of 1M ATM 0.51 delta calls and 1 lot of ATM -0.49 delta puts of 3m expiries, these options positions construct smart hedging at net debit.

The strategy is likely to mitigate both bullish as well as bearish risks irrespective of spot moves. However, on speculative grounds, more potential is foreseen on the upside. Please note positive cashflows whether underlying spot keeps flying or dipping.

Currency Strength Index: FxWirePro's hourly GBP spot index is inching towards -34 levels (which is bearish). Hourly USD spot index was at shy above 3 (neutral) while articulating (at 07:13 GMT).

For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex

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