FxWirePro: FVAs in USD/BRL as vols turning lower in H1 2016

Short 6M in 1Y time FVAs in USD/BRL: Since Funding valuation adjustment is essentially the funding cost/benefit resulting from borrowing or lending the shortfall/excess of cash arising from day-to-day derivatives business operations (for an instance, posted and received collateral).

These collaterals are radically contrarian position that should sustain in reasonably well even if we do get the 6% drop in the real that it is pencilled in for H1.

ATM vols in USD/BRL have already turned lower from remarkably overbought levels aided by soft realized performance in recent weeks (3-4 pts. under) yet forward vols are lagging and are priced 2-2.5 vols above.

We would not like to disregard the probabilities of vol bouncing back again in the short run, and BRL spot FX certainly can swing wildly in a way that would make selling realized vol (gamma) a distinctly uncomfortable stance to take.

But think that 20-handle forward vols will have a hard time realizing by the end of the year when greater clarity would have emerged on Brazilian politics and EM overall would have settled down after initial Fed-related tremors.

Hence our decision to take gamma out of the equation via an FVA short that benefits from implied vols falling short of what forwards price in by end-2016.