FxWirePro: Stochastic oscillator indicates striking alpha opportunities in G10 FX options space

The potential of trading live (non-delta hedged) FX options is explored based on a well-known and broadly used FX cash leading technical indicator: stochastic oscillator index. The idea is that stochastic indicator can spot early signs of slowing or reversals in trend that consequently can be capitalized via rich universe of directional FX option structures.

“Buy” (“sell”) reversals are signalled when the indicator is below 40 (above 60) and is exhibiting higher lows (lower highs). Option trades (non-delta hedged) are entered on the following trading day and held to maturity. 

The back-test (2005-present, conducted on G10 USD pairs as one basket and EM pairs as the other basket) shows that by using stochastic oscillator reversal points to time trade entry into short-tenor directional option structures, long- term cumulative returns can be boosted by more than 100bps per year (refer 1stchart). 

Notably, a sizable portion of the observed returns comes from fading momentum of an existing trend. This makes selling put options on “buy” signals and selling call options on “sell” signals along with owning risk reversals on "buy" and selling them on "sell" signals two favorable expressions that utilize stochastic oscillator (refer 2ndchart). 

In the G10 space, most recently stochastic oscillators indicated: 

1) The bullish reversal for USDCAD on Aug 2, AUDUSD and EURUSD on Jul 20, NZDUSD on Jul 16 and GBPUSD on Jun 29 – best expressed via long 1M risk reversals or short 1M ATM puts. 

2) The bearish reversal for USDNOK on Jul 27, USDCAD on Jul 20, USDCHF on Jul 16, USDJPY on Jul 3 and USDCHF on Jun 29 – best expressed via short 1M risk reversals or short 1M ATM calls. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly AUD spot index is inching towards 65 levels (which is bullish), while hourly USD spot index was at 17 (neutral), NZD at 138 (bullish) and CAD at -165 (bearish), while articulating (at 12:32 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex