FxWirePro: EUR/PLN OTM calls conducive for expressions of short EMFX and high-beta G10 FX vol

The European Commission decided to go ahead and refer Poland to the European Court of Justice (ECJ) on alleged violation of judicial independence through its new Supreme Court act. EC warned the Polish government not to proceed with the contested law until ECJ has reviewed the challenge. We foresee EURPLN rising mildly to 4.40 levels over the coming year.

Maintain over-weights in Polish zloty as FDI flows begin to recover. The shorts in USDPLN cash position are recently restructured into a more conservative option exposure which limits our downside risk. A lack of any strong growth recovery in the Euro area will likely limit outright gains in CEE. However, we continue to look for PLN outperformance given strong domestic data and FDI recovery.

While we like the following expressions of short EM and/or high- beta G10 FX vol: 

OTM EURPLN calls: Our EMEA team has a constructive take on the zloty, which is a first order source of comfort for vol sellers. Exposure to a slow burn recovery in the Euro area, strong domestic dataflow that has anchored growth forecasts at an impressive 3.8% pace for 2H’18 and revival of FDI inflows are FX positives that should promote PLN outperformance vis-à-vis regional EM peers. 

On the vol side of things, EURPLN risk-reversals have been elevated for a while (SABR implied spot-vol corr for 3M riskies 42%), but it is only in the past couple of weeks that realized spot-vol corrs have plummeted (10-day spot-3M ATM vol corr. -20%) and created genuine value in selling OTM EUR calls on the surface. This is better done in shorter rather than longer maturities given the flatness of the vol curve. 

For instance, 2M 25D EUR calls at 6.3 vol are priced at a 1.5 vol premium to trailing 1m realized vol. We prefer taking advantage of this richness via short EURPLN – long EURUSD option spreads using OTM EUR calls. 

The rationale is two-fold: (a) neutralization of Italian budget risks inherent in selling EUR-cross options; and (b) the long vol hedge is efficient on a standalone basis and does not detract from core short vol P/L: in contrast to the EURPLN surface, OTM EUR calls are priced at a discount on the EURUSD surface, and gamma is much firmer. The net result is a positive carry vol spread construct that has decent potential for mark-to-market gains from a re-pricing of implied vols (refer above chart). Courtesy: JPM

Currency Strength Index: FxWirePro's hourly EUR spot index is flashing at -95 levels (which is bearish), while hourly USD spot index was at 156 (bullish) while articulating at (13:42 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex