FxWirePro: GBP/JPY “Reverse Put Spreads to sync with OTC indications for optimized hedging

Please be noted that the 1m implied volatilities of GBPJPY are spiking above 13.10%, while positively skewed IVs signifies the hedging interests in OTM put strikes.

In spite of GBPJPY downtrend seems to be intact, a lot of bad news is already priced in and digested by the market. Brexit caused two Sterling debacles, first in June with the vote and then after the summer when PM May suggested a hard exit.

GBPJPY lost over 3-4% over this quarter with one fortnight to spare and it doesn’t seem the dust has settled. In the process, volatility fell but remained relatively high on a historical basis.

Assuming a medium-term range in this pair and that negative surprises are no longer market tail risks, the GBP volatility is still short.

Even if the aggressive volatility investors want to capture GBP should consider buying ATM put instruments and/or being long of the smile convexity, against ATM volatility.

But further GBPJPY weakness and/or abrupt upswings suggests building a directional and volatility patterns at the same time: the value of OTM puts would likely to rise significantly as the IVs seem to be favoring these distant strikes. We, therefore, recommend buying a 1w1m IV skews and risk reversal with ATM options.  

Subsequently, since 1m implied volatilities are considerably spiking on higher side that is most likely to favor vega puts in the robust downtrend.

As a result, we believe in jacking up in long leg of the below option strategy:

Initiate longs of 2 lots of 1m at the money vega put options, simultaneously, short 1 lot of (1%) out of the money put of 2w expiry with positive theta. It is advisable to prefer European style options.