Please be noted that the risk reversal flashes across all tenors, although we see positive changes to the bearish risk sentiments across all tenors, hedging sentiments for bearish risks remain intact, whereas Euro seems to be losing traction in next 3 months tenor ahead of French elections.

On the flip side, USD’s robustness seems more attractive than euro on account of series of significant events such as the Trump’s stringent protectionism regulations, while the Fed’s chances of hiking in 2017 can certainly not be disregarded.

Moreover, all these factors are discounted in FX option market. You could make out this in mounting risk sentiments as you could see the positively skewed IVs in OTM put strikes.

Well, these positive skews in 3m implied volatilities suggest RKO calls on both hedging as well as speculative grounds, the EURUSD 2-3m skew has been well bid with Trump progresses in the beginning months to come. 1m IVs are tad below 8% (lower IVs good for option writers), while 3m IVs rising above 10.39% (higher IVs conducive for options holders).

We reckon the above fundamentals seem to be reasonably addressed by hedging participants, hence, contemplating above risk reversals and IV indications, we advocate below option strategy to mitigate risks on either way with cost effectiveness.

Hedging Framework:

Strategy: 3m 3-Way Diagonal Straddle versus OTM call
Spread ratio: (Long 1: Long 1: Short 1)

Rationale: Let’s glance on sensitivity tool for 3m IV skews would signify the interests of OTM put strikes that would imply the ATM puts higher likelihood of expiring in-the-money, so writing overpriced OTM calls would be a smart move to reduce hedging cost.

The execution: Go long in EURUSD 3M at the money -0.49 delta put, and go long 3M at the money +0.51 delta call and simultaneously, Short 1m (1%) out of the money call.