FxWirePro: Risk-efficient short gamma trading in USD/INR through 3M-1Y calendar spreads on RBI and Modi’s regime

The USDINR had recouped all the lost incurred since the Q4 demonetization phase, the drop in the spot over the past two days cleared the 66.0 level in a decisive way not witnessed since 2015, and caused an uptick in front-end vols (refer above charts).

With dealer activity unlikely to account for large price movements in our opinion, ex-post explanations for the move always involve considerations of looser RBI reserve accumulation, Modi’s blockbuster legislative election win and prospects for further structural reforms, support from the drop in Oil prices and real money flows.

Most of the Asian FX strategists hold a neutral view on the currency and have suggested that chasing moves lower in USDINR doesn’t present great risk/reward perspectives. The dynamic of portfolio inflows into the fastest growing major economy, contained by RBI intervention, is likely to remain in effect, especially since India has been left out of the trade tension narrative pushed by President Trump.

Note that RBI actions lead to India ranking third in terms of the size of FX intervention behind Switzerland and Taiwan, but the pace of intervention is far below the 2% GDP threshold that raises eyebrows in the Trump camp.

Over the past few years, USDINR has been the pair where short gamma strategies have delivered their highest Sharpe ratios, along with EURUSD and USDSGD (refer above charts).

Unlike in EURUSD however, overlaying a long vega leg, resulting in vega-neutral positions, has improved risk/rewards significantly and led to an appreciable alpha generation strategy.