FxWirePro: EUR/USD downside risks mounting – why to avoid OTM instruments in option strips

The ATM volatility and delta risk reversal of EURUSD, divulge that the fact that pair would experience little downside pressure in next 1-6 months future with reducing volatilities. Although trend is puzzling on either sides the bearish momentum is likely to hold on.

The spot FX EURUSD is flashing up at 1.1228 with negative delta risk reversal has been gradually picking up after 3 months which means fed's rate policy expectation that is scheduled in December cannot be disregarded, an investor may want to protect his asset from downside price risks on euro side. So, he considers buying a EURUSD put assuming scenario that dollar's strength owing to rate hike.

On hedging grounds we prefer buying ATM 1W 0.52 delta call of 1 lot instead of OTM calls and two lots of ATM 2M -0.48 delta puts on the other hand. You aren't sure of the direction though, but you favor the downside. Our analysis tells you a southward big move is on the table. You enter a long straddle trade with an extra put in hopes of a move down.

If the options are far out of the money they will not appreciate in value fast. Chances are even if a movement comes you may not make sufficient money to make the trade profitable. There are two reasons for this:

Delta of far OTM options is very small. A 1 point movement in EURUSD will not have much effect on the option premium. While theta will also eat premium every day. If the expiry is near and the option is still far, it will actually decrease in value even if the pair moving in its direction. After the news volatility crunches. The option premium will reduce anyway. A buyer has to fight this as well.