FxWirePro: USD/JPY RRs indicate intensified bearish sentiments ahead of Fed and BoJ, 1m balanced IV skews to substantiate

Please be noted that the implied volatility of ATM contracts of USDJPY across 1w-1m tenors are shrinking lower despite this week’s monetary policy meetings of Fed and BoJ, just shy above 10.85% and 9.35% for 1w – 1m tenors respectively, while risk reversals have been adding up higher negative numbers to signify the bearish hedging sentiments.

With the help of this OTC setup, the rationale is that any abrupt upswings should be optimally utilized to snap rallies and deploy short puts in order to reduce the cost of hedging.

Thereafter, to arrest potential downswings to maximum extent regardless of trading or hedging grounds, so to participate in that downtrend, weights of the long leg in hedging portfolio should be increased with more number of put contracts but consciously while choosing the right delta instruments.

Implied volatility is an important factor to consider in options trading, because the prices of options are directly affected by it. A spot rate with a higher volatility will have either had large price swings or is expected to, and options based on a security with a high volatility will typically be more expensive. 

Please also be noted that the IV skewness are very conducive in determining this decision, here in case of USDJPY, one could easily make out positively skewed IVs are signifying the importance of OTM puts but not deep out of the money puts (3m skews are suggesting strikes maximum upto 107). This bearish sentiment is in sync with the mounting negative risk reversals that again indicates further bearish risks.

Well, this is intuitive due to the higher likelihood of the market 'swinging' in your favour. If IV increases and you are holding an option, this is good. In contrast, if it goes in adverse direction, then one should raise a cause of concern for his option strategy.

A smart approach to tackle this obstacle and potentially profit from volatility is to create a delta neutral position on a security that you believe is likely to increase in volatility. The simplest way to do this is to buy at the money contracts or OTM strikes but certainly not deep OTM strikes.

Currency Strength Index: FxWirePro's hourly USD spot index has shown 66 (which is bullish), while hourly JPY spot index was at -74 (bearish) at 08:02 GMT. For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex.

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