The stakes are high this week. A big shift in the trajectory of inflation in Australia would threaten both our view that the market will not move to price in hikes into the OIS strip, and that the AUD remains capped, with a range top at USD0.7850.

However, this is not our core view. A number of factors (rising under-employment, retail sector competition, and soft rental markets) all continue to suggest that we have not reached a significant point of inflection for core inflation. As such, the strategy into the number is to sell any strength in the AUD or any attempts to price in a tightening track for the RBA. 

OTC Updates and hedging framework:

1W at the money volatilities of 50% delta calls and puts are hovering between 6.5% - 7.5% which is reasonable as the vols currently are working in the interest of option writers as you can see IVs and corresponding movements in vega.

Contemplating fundamental aspects and the current trend of this pair, the ATM IVs are creeping up at 7.94% and 7.49% of 1m and 1w tenors respectively that favor option writing rather than holding in short run.

While ATM puts are priced exorbitantly at 48% more than NPV, hence, we see a huge disparity between IVs and pricing. So, one can think of writing ITM puts with narrowed tenor combining ATM and OTM longs in put ratio back spreads.

The typical position combines buying at-the-money or out-of-the-money puts and, at the same time, selling a smaller number of in-the-money puts. Those in-the-money puts are always at risk of exercise, but you have two advantages.

First, the assignment can be covered by the long puts; second, time decay and implied volatility work in your favor on the short puts. This points out the importance of entering the position when implied volatility is higher than average.

The short position puts (which are in the money) will yield more premium income than the cost of the higher number of at- of out-of-the-money long positions. The ratio itself should vary depending on your belief in the strength, direction and timing of price movement, and also on the cost for each side. Creating a net credit is always desirable, so this also affects how many short and long puts you open.

Another issue is determining which strikes you should use in this strategy. The broader the strike difference between short and long puts, the fewer puts you need to sell to cover the price of the long puts. But at the same time, the coverage of long-to-short is going to be more difficult in the event of assignment.