FxWirePro: Spot the benefits of synthetic short EUR/USD delta exposure via EUR/CNH

One way of reducing/eliminating premium outlay on hedges is to fund OTM USD calls/CNH puts with shorts in EUR calls/CNH puts to effectively create synthetic short EURUSD delta exposure. The attraction of funding via EURCNH options is two-fold.

First, EURCNH is not just any random EUR-cross; since the institution of the RMB basket mechanism in late 2015, EURCNH has acted as a loose (inverse) proxy for the CNY TWI itself given the meaningful (16%) weight of the Euro in the basket. If the CNY basket is poised for mild appreciation this year as our Asia team anticipates, it stands to reason that upside in EURCNH should also be limited.

The sideways price action in the cross over the past 6-months is representative of what is likely to unfold in a stable/constructive CNY TWI environment.

Second, reasonable option premium can be collected from selling EUR calls/CNH puts due to negative points carry on both the EUR-and CNH-legs, which offsets some of the disadvantages of depressed EURCNH vols relative to USDCNH vols in an elevated USD-correlation environment (see above chart, LHS).

A potential pushback against selling EURCNH calls is that a Euro surge of the kind seen in 3Q’17 could drag EURCNH higher even absent a USD revival; it is a fair critique, but one we judge is low probability at the moment since the unique initial conditions associated with that Euro move – a sizeable risk premium in the currency coming out of the French election non-event, clean spec positions and the surprise/shock effect of the Draghi’s hawkish policy turn at Sintra –are no longer present.