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FX vols in the uncharted territory as VXY-G10 touches 5.0 making the new historical low. We remain on lookout for pockets of risk premium. Risk markets have enthusiastically embraced the consensus that US/Iran tensions have been put to bed for now, and there appears to be broad agreement among macro investors that there is a runway for cyclical trades to perform in 1Q’20 as rest-of-the-world growth begins to look up and US/China trade tensions take a backseat. This is welcome news for vol sellers on the whole, but it does not necessarily open up a wide array of short vol opportunities in FX given that FX vols are making new historical low of 5.0pts (basis VXY- G10, refer 1st chart).
Yet an average 3M vol premium in FX is roughly 0.6 vols wide (equal weighted basket of liquid G10 & EM USD- pairs), which still leaves room for selective carry collecting via short-gamma trades. The cost of holding the gamma end of the curve has been worth 12vol pts in 2019.
FX sensitivities to global market factors has declined as of late (refer 2nd chart) and amid the benign global backdrop last week we re-entered a theta-collection strategy outlined in the Year Ahead Outlook 2020 of selling USDJPY risk- reversals via 1*1.5ratio USD put/JPY call spreads (delta- hedged).
We remain of the view that the macro backdrop is tactically supportive of income harvesting where opportunities exist and we add to the model portfolio 6M delta-hedged MXN ratio spread and a hedged short vol in TRY. Courtesy: JPM
