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Indian rupee is giving up against the US dollar on the back of strong US data, progress in US tax reform bill and Powell's statements indicate December US Fed rate hike is on track.
While low realized vol and technical support still indicates RKO put strategy, INR volatility stalls in the low vol bloc among the EM space (3m vol is trading below 6) but realized vol has remained constantly lower than implied vol since start 2016. The market is, therefore, pricing a premium not justified by the volatility of the FX rate.
This suggests selling volatility, and our USDINR bearish view combined with a strong technical support makes an RKO put attractive. While the skew oriented to the topside won’t provide an extra discount on the premium, such a positive skew indicates that market volatility should fall as the spot goes lower.
The rupee is strong on the back of custodial flows and upbeat GDP flashes. We continue to foresee USDINR to trade in a range of 63.25-65.55 in the months to come.
Buyback of short-dated bonds by the government is positive for the bond market. Traders are now excited about GDP data. Q3 GDP increased to 6.3% YoY. The firmer growth was widely expected after the dual shocks that weighed on growth in H1, namely the surprised demonetization last November and the GST roll-out in July this year.
Consequently, we advocate buying USDINR 2m put strike 65, knock-out 63.50 Indicative offer: 0.21% (vs 0.49% for the vanilla, spot ref: 64.53).
For USDINR, it closed slightly higher yesterday around 64.50. We suspect RBI will be content to see it trading sideways in near term given the relatively stable inflation outlook around the 4% target.
FDI flows will likely continue to support the modest CA deficit. Higher FPI limits provide some additional space for foreign inflows, especially in corporate bonds. However, given the risks of the substantial inflows into local bonds this year ($20bn) reversing, we prefer downside option structures to NDF exposure.
The option will lose the premium paid if it doesn’t end below the strike (65) or touches the knock-out barrier (63.50) at any time during the life of the option.
