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1W and 1M ATM IVs of GBPJPY are rising in OTC markets, flashing a tad below 13% and 12.29% respectively on the BoJ’s monetary policy.
1w IV skews are equally interested in both OTM calls and OTM puts, while 1m skews signify the hedging interests in OTM put strikes as the BoJ shifts policy framework to targeting Japan’s yield curve.
Implied volatilities skews of ATM puts of 1m are positively correlated to the OTM strikes as the BoE governor Carney’s speech tomorrow will be the key, with the inflation report seeing expected effects from Brexit on the real economy. Markets are observing whether UK central bank hints on with another 25bp cut in Bank rate and some looking for more QE or change its easing views as PMIs of all sectors indicate the recovery in business environment observing to the previous easing in bank rates.
In spot FX of GBPJPY, although upswings were observed to hit the day highs of 133.261 soon after BOJ’s decision, technically the pair has again drifted below 7DMAs to the current 132.151 levels, what is weighing on the pound's slumps is that, the expectations on BoE monetary policy changes but the chances for lower interest rates in 2016 has grown up, above all lingering post-Brexit formalities adding an extra pressure on sterling's depreciation.
Accordingly, we think arresting potential downside risks of this pair by hedging through Put Ratio back Spread, for now, it is reckoned that the underlying currency GBPJPY to make a large move on the downside in spite of any abrupt upswings.
Hence, we advocate the suitable option strategy to hedge the potential downside risks by using any small bounces through ITM shorts, this would have certainly ensured returns in the form of premiums.
So, stay firm with longs on 2 lots of 1M At-The-Money vega puts that would function effectively in higher IV times, long instruments to generate positive cash flows as underlying spot keeps declining as you can observe the exponential positive cash inflows, whereas the maximum losses are limited regardless of spot making any upmoves (see payoff structure in diagram).
Shorts leg of 1 lot of 1W (0.5%) ITM put option would generate assured returns on any abrupt rallies and reduce hedging cost of long legs.
