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Japanese Yen outperforms in risk-off mood; while BoJ doesn’t cut, doubles asset purchases. The temptation is to be long the USDJPY for now. But with implied vols still elevated and risk reversals heavily favouring USD puts, we continue to look for USDJPY downside.
Earlier this week yen vol curve has inverted the most since GFC and retraced 70% of the 2008 peak (refer 1stchart) while widening of the risk reversals (in relative terms to ATM vols) has even exceeded the GFC levels. That dislocation has started to reverse.
Our yen analysts see USDJPY above 100. If not for liquidity constrains a contained yen upside could be efficiently expressed via defensive USDJPY OTM put calendars that utilize the once in a generation skew-vol setup.
We opt for fading the curve inversion via vanillas on the weak side of the riskies to avoid left tail exposure. The - 1M/+2M and -2M/+4M call calendars are the sweet spot showing the most attractive trade-off between pay-out and static carry characteristics.
Conducting terminal payoff analysis across various spot and vol scenarios in 2nd chart, we track net P/L at expiry of front tenor leg (i.e. aged calendar) across the space of +/-6% spot and +/-4 vol outcomes. The payoff grid shows the -2M/+4M USDJPY 30D calendar to have well defined downside and positive P/L in most scenarios.
Consider: Short 2M vs long 4M USDJPY 110 (30 delta) strike vanilla call calendar (non-delta hedged) costs 45bps USD, 70% discount to 4M outright, spot ref 107.40. Courtesy: JPM
