FxWirePro: Spot out anomalies of delta-hedges in USD riskies, safe havens FX to buck the trend for positive carry

One of the most visible effects of this year’s dollar weakness is the relentless narrowing of risk-reversals in USD pairs, particularly since mid-Q2 once the French elections were out of the way.

Initially, softer riskies simply reflected a lowering of European political tail risks, but skew compression accelerated from June onwards as investor demand for USD puts – especially fueled by the Euro surge –pushed vols higher and turned the usual positive spot-vol correlation in USD pairs on its head.

Unsurprisingly, returns from owning delta-hedged USD riskies have been deeply negative owing to a mix of this surface re-pricing but more crucially smile decay: the above chart shows that the scale of the P/L penalty from owning USD calls over the past year far exceeds moves in implied vols alone.

Only two currencies – JPY and CHF –managed to buck the trend of unprofitable USD call ownership, less due to favorable directional moves over this and more because of earning smile theta with riskies priced in favor of USD puts in both cases. USDJPY may be a questionable candidate in light of brewing political risks in Japan, but USDCHF (3M 25D RR -0.8, 1Y -1.1) can act as a carry-positive overlay on bullish Euro positions and/or a hedge against an unexpectedly potent tax reform developments out of Washington. Courtesy: JPM