FxWirePro: NZD/USD IV skews and macros signal bearish risks – Vanilla options, RVs and KOs trades to hedge

NZDUSD continues to gravitate slowly towards 0.6900, thanks to a firmer US dollar since late March.

The pair in medium term perspective:  Potential for higher to the 0.7150-0.7300 area during the month ahead, as USD longs are paired. Further out, the Fed’s tightening cycle plus US fiscal expansion should maintain upside pressure on US interest rates and the US dollar, pushing NZDUSD down towards 0.6900.

Weaker dairy prices plus the RBNZ’s emphatic reminders it is on hold for a long time should also weigh. In New Zealand, business confidence dipped and credit conditions stayed tight.

Option Trade Recommendations:

Moreover, all these factors are discounted in FX options market. You could make out this in mounting risk sentiments as you could see the positively skewed IVs in OTM call strikes.

The NZD volatility market normalized sharply (you could observe that in NZDUSD IV skews across all tenors) and IV skewness is quite favorable for OTM put option holders.

Well, these positive skews in 2m implied volatilities signify hedging interests in downside risks and the combination of IV 3-6m skews suggests RKO calls on both hedging as well as speculative grounds, the NZDUSD 2-3m skew has been well bid with Fed’s hiking expectations in June meeting and global commodity price turbulence.

Initiate long in a 4-month NZDUSD 0.64 vanilla put.

Initiate long in a 4-month NZDUSD 0.64 put with a KO of 0.7559 calls in AUDUSD.

Short a 2-month NZDUSD AED call, strike 0.7095, buy a 2-mo AED put, strike 0.6641.

While the baskets of EUR-crosses that rally alongside EUR/USD do not offer much by way of correlation savings since EUR based correlations have climbed appreciably this year. The above chart runs through a pricing exercise of this family of structures across various pivot currencies and shows that KRW, NZD, and AUD offer the best value.

Since the broad dollar is trading meaningfully cheap to rate differentials, USD legs in this set-up need be struck more conservatively (ATMS) than the EUR-cross.

2M [EURNZD > 1% OTMS, NZDUSD > ATMS] dual digital costs 15.2/18.7% NZD indic. (indiv. digis 44.3% and 52.8% respectively).