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In our view, FX options markets complacency and the timing (only one more week to go) make for a good setup to for adding last minute, low downside risk hedges.
Based on the reaction to past elections, and taking note of the moderation in MS5’s euro-skeptic position, we suggest maximum downside in EURUSD of perhaps 3% on a non-mainstream government, so a floor of 1.20.
Forward volatility hedges: Though fairly modest by comparison to the French election, Italian election risk premia has still distorted EUR and EUR-cross vol surfaces with post-1M curves inverted as the event risk effects fade rapidly (refer above diagram).
The dynamics of implied vols (contrary to realized vol/gamma which explodes when spot reacts violently to a shock result – thus the gamma hedges above) is complex due to the interplay between a collapse in implied vols as day-weight rolls off and the reaction to a new political reality that eventually re-sets implied vol higher.
However, as witnessed in the post-Brexit period, the prolonged uncertainty from an adverse political event can eventually deliver substantial positive returns to forward vols. At a discount to already attractive spot 1M ATM vols and priced 1-1.5 vols below recent highs, EURAUD and EURCAD 1Mx1M fwd vols strike us as relatively attractive, asymmetric downside risk hedges (refer above diagram). Courtesy: JPM
Currency Strength Index: FxWirePro's hourly EUR spot index has turned into 48 (which is bullish ahead of manufacturing PMIs, unemployment rate, 10Y bond auction in Eurozone for today, and German retail sales data prints for tomorrow), while hourly USD spot index was at shy above 25 (mildly bullish ahead of US unemployment claims and Fed chief Powel testimony) while articulating (at 07:33 GMT). For more details on the index, please refer below weblink:
http://www.fxwirepro.com/currencyindex
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