FxWirePro: GBP/USD OTC “blowing out of proportion” - offset expensive ATM puts with option arbitrage

The cable has cleared all crucial support zones, although bearish trend is on but don't expect steep slumps.

As a result of bearish sentiments mounting in spot FX, OTC markets look like overreacting, please be noted that the premiums for 1w ATM put are USD 728.44 for lot size 100,000 units which is 19.41% higher that NPV at 610.60.

This is not justifiable while tracking IV factor as these contracts don't seem to be moving in sync with vols.

Since the cable's implied volatility is still perceived to be the least within next 1w-1m time frame from other major G7 pairs (at around 6-8%), we wouldn't see any dramatic fluctuation on the underlying pair.

Hence, comparing this difference in options premium with implied volatility and market upward sentiments we think the hedging cost for downside risks would not be economical as result of deploying ATM instruments considering short term downswings.

Alternative scenario: We cannot afford to get stuck in this riddle without hedging, so what's the alternative, in forwards markets at least..?

Subsequently, here comes the arbitrage strategy in which options trading that can be performed for a riskless profit as GBPUSD ATM puts options are overpriced relative to the underlying exchange.

To perform this conversion, the hedger shorts underlying spot FX and add longs ATM calls. The synthetic long put is so named because the established position has the same profit potential as these ATM long puts.

Profit is locked in immediately when the conversion is done, the profit would be Sale Price of Spot FX - Spot FX - Premium Paid.