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The FX volatility market has so far in 2019 failed to display any material inversion of the bearish trend started in mid- 2016. Most of the 0.7 vols rise in the J.P. Morgan VXY G7 Index since mid-July can be attributed to the Brexit risk premium impacting cable’s vol, whereas the EM Index, at present just 0.7 vols above the DM one, has continued a steady drop. A few weeks ago we had pointed out to synchronous dovish-sounding Central Banks as a key factor in keeping vol levels suppressed contemplating assessment of the impact of rates correlations on FX vols by JPM analysts. A less dovish than expected ECB yesterday is not dramatically altering this picture so far, at least on FX.
The short-Gamma/long-Vega trading theme, benefiting on the one hand from suppressed realized vols, and, from the other, from a possible rebound in vol levels, remains relevant for the present market conditions, at least over a multi-week horizon. The first topic will be analyzed by commenting on the performance of a filtering methodology applied to short 1M FX trades, which has kept on delivering a steady performance this year despite the suppressed vol levels.
The long-Vega theme will be specifically investigated from the perspective of long-dated vol ownership which, supported by positive carry in the underlying asset, can permit obtaining under certain conditions a positive time decay for the options premia. We then present some ideas on how to play a weaker EUR via L/S directional option structures.
FX short-Gamma strategies have delivered very solid performances over the past three years. While the strategic potential of selling assets trading near multi-year lows is questionable, from a purely tactical perspective, short-Gamma trades could nonetheless benefit from:
a) suppressed realized vols, implying b) positive (if not wide).
We introduced a tactical filter for timing FX short-Gamma trades (1M 25-delta strangles) in a recent piece (Timing FX short-vol strategies). EURUSD, USDCHF, USDMXN, and USDCNH are the sole four case where the latest trading signals by the model are below 100% (max short-vol capacity). As we can see from the above chart, the average signal for short-Gamma as recommended by the model has gradually increased from the late May lows, when trade wars and monetary policy uncertainties were weighing on vol premia, suggesting a more cautious stance. Courtesy: JPM
