FxWirePro: Straddle Longs Versus Strangle Shorts as Defensive Gamma for Apprehensive Kiwis Ahead of RBNZ

The RBNZ is scheduled for monetary policy next week, the Kiwis central bank surprised markets last month adopting an explicit easing bias. The shift caused oversensitivity to data prints. With a busy calendar ahead of us we reckon that it is prudent to add defensive gamma in idiosyncratically troubled currencies such as NZD and AUD to short vol portfolios. 

In addition to the usual daily realized vol (and exponentially weighted vol) we also track high frequency, short term, realized vol (hourly) in order to gauge persistency of the realized vol trends as well as for spotting major shifts (refer 1stchart).

The 2ndchart analyses options event risk pricing (overnights breakevens) with respect to the observed 1-day spot moves. It shows that pricing of the major data prints exhibited fat right tails during the last 3 months, i.e. it is worth being long gamma over the events. We hypothesize that such dynamics are going to persist. 

However, such gains are short-lived and not enough to offset the time decay over longer periods. The long term performance of the delta-hedged 2M straddles in NZDUSD, NZDJPY and EURNZD tend to succumb to decay (refer 3rdchart). Absent broad-based change in risk sentiment, gamma spikes are likely to continue being short lived and with limited impact on vega tenors. That is supportive of constructing calendar structures. With a P/L beta of about 50% of the outright long gamma, vega neutral (and delta-hedged) calendars are better suited for playing long event risk. The structure exhibits minimal or no decay while providing long gamma exposure. 

The recent heightened sensitivity to the data prints (as witnessed following the Wednesday CPI data print) warranties solid AUD gamma performance, which makes us comfortable expressing the below structures equivalently in AUD as well.

Trade tips: We recommend buying 2M NZDUSD straddle 7.85/8.2 vs shorting 9M 25D strangle @8.6ch, in vega neutral notionals, delta-hedged. 

Buy 3M NZDJPY straddle 8.9/9.2 vs shorting 9M 25D strangle @10.10ch, in vega neutral notionals, delta-hedged. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly NZD spot index is inching towards -139 levels (which is highly bearish), hourly JPY is at 43 (bullish), while hourly USD spot index was at 6 (neutral) while articulating (at 13:02 GMT). 

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex