FxWirePro: EUR/PLN debit put spread hedges Polish zloty's unstoppable gains

EUR/PLN is forecasted at 4.20 by end of Q1. This is despite EUR/PLN overshooting in January's series. We believe the pace of PLN appreciation against the EUR will accelerate after Q1 once there is more clarity on MPC's new composition and the government's decisions on a banking tax and conversion of CHF-mortgages. First, EUR/PLN recently overshot largely because of ECB's last meeting.

The ECB delivered the extended QE programme we were looking for (now due to run at least until March 2017) but not the full depo cut we had in mind (-10bps instead of -20bps). There were also many looking for an expanded pace of asset purchases but the ECB opted instead for a programme of reinvestment as existing holdings mature.

We would look forward for a very limited price effect only on the PLN on a time extension of QE, as a result, we look to initiate short EURPLN positions ahead of the March and June ECB meetings once market volatility dissipates and although acknowledging some upside risks to our EURSEK forecast path.

EURPLN has been consistently slumping from the highs of 4.5120 to the current 4.3675 levels.

So, on a hedging grounds, use a Bear Put Spread over a naked long put as ATM puts are overpriced (19.2% above NPV but IV is just shy below 8.81%)and this disparity is not conducive for the prevailing underlying spot FX which is only expected to move marginally lower in the weeks to come.

Thus, go long in 1M (1%) in the money 0.61 delta put and simultaneously, short 1M (1%) out of the money put with theta closer to zero for net a debit.

Maximum Loss: Limited to extent of initial premium paid.
Maximum Gain: Limited to difference between Strike Price - Initial Premium Paid.
Breakeven Point: Long Put Strike Price - Initial Premium Paid.

As shown in the diagram, by shorting the (1%) out of the money put, the options trader reduces the cost of establishing the bearish position but forgoes the chance of making a large profit in the event that the underlying price plummets.