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Trump victory would probably maintain a high level of policy uncertainty – both the US and global. Investors indeed would wonder about the degree of implementation of his radical proposals: tax cuts and infrastructure spending threaten fiscal stability, while his protectionist and isolationist bias would hurt international trade and foreign direct investment.
Those threats, however, would largely be global rather than US-centric – the impact on the USD is less clear.
Trump’s victory would, in fact, prop up US corporation profit repatriation, while the looser fiscal policy would potentially direct to both a tougher Fed and higher long yields, potentially USD-friendly developments.
We are fundamentally bearish the lira but await better entry levels to go outright short again. The CBRT’s persistent dovishness and a widening current account deficit should fuel TRY weakness over the coming months, in our view.
This is likely to push TRY implied yields lower, making the lira the cheapest high yielding EMEA EM currency to short. Since Moody’s ratings downgrade of Turkey on 23 September, USDTRY is over 3% higher, but domestic FX selling at current levels is likely to cap near-term lira depreciation.
As a result of above fundamental factors, a rich USDTRY skew compared to implied volatility, the USDTRY is on the verge of all time highs and is a more appealing options hedge against a Trump victory versus other currencies.
ATM volatility returned to the non-distressed region (below 12), while topside exposure can be the most advantageously cheapened.
Among USD EMFX volatility smiles, the USDTRY 3m risk reversal is the highest compared with 3m ATM volatility, strongly suggesting dollar calls that sell topside skew.
The execution of the strategy: Buy 3m USDTRY call strike 3.16 knock-out 3.41, indicative offer: 0.67% (vs 2.34% for the vanilla, spot ref: 3.0936).
The risk is foreseen at a spike of +10% in the next three months Investors buying a knock-out call cannot lose more than the premium paid. However, the option will disappear if the USDTRY hits the 3.40 level at any time before the 3m expiry.
