FxWirePro: EUR/JPY mounting hedging sentiments in major downtrend – Add vega longs in put back spreads as RR and IVs highest among G7 space

As the delta risk reversals of euro crosses (especially in EURJPY) have shown a mounting bearish interest as the progressive increase in negative numbers signify the traction for hedging sentiments for further downside risks in both short and long term. EURJPY is the highly perceived pair to have bearish risks (see for the highest negative numbers among G10 space).

To substantiate this bearish stance, positively skewed IVs of 1m tenors are signifying the hedgers’ interests in OTM put strikes. This implies underlying spot likely plummet further southwards.

Since EURJPY OTC markets seem to be the highly volatile pair as well with the extremely bearish environment, and IVs for 1M contracts are the highest among G10 FX space (above 17%) amid European election season. This would be good news for option holders contemplating the prevailing bearish environment but more number of longs in ATM delta puts would ensure the reasonable probabilities in underlying exposures.

To factor in the weakness in this pair as we could see reasonable IVs even in next 1-3m expiries, we recommend capitalizing more on bearish signals and the IV factor in the long term by employing OTM longs matching with ATM longs to construct back spreads that likely to fetch positive cash flows.

So, here goes the strategy this way, Go long in 1 lot if 1M ATM vega put, long in 2M (1%) OTM vega put, and simultaneously short 1W (1%) ITM put, the spread is to be executed in the ratio of 2:1 with net delta at around -0.70. Vega instruments during highly volatile environment are most likely to fetch beyond usual yields when underlying spot keeps moving anticipated directions.