FxWirePro: USD/JPY diagonal put ratio back spreads, a hedging perspective - Short leg on track of funding long legs

USDJPY has significantly risen from the lows of 104.629 levels to the recent highs of 107.493 levels. Amid major downtrend with minor abrupt rallies, we’ve already advocated diagonal put ratio back spread about two weeks ago. For now, short legs of this strategy would have fetched attractive yields as the underlying spot FX has significantly spiked above, while long legs are yet to function having two months of expiry.

While the implied volatility of ATM contracts of USDJPY is trading back towards 7.5% for 1-3m tenors, as the positively skewed IVs of 2m tenors signify the hedging sentiments for the further downside risks over the period of time, this appears to be conducive for put option holders. Despite the positive shift in risk reversal numbers, the hedging sentiment for the bearish risks appears to be intact. On the flip side, it is wise to utilize abrupt rallies amid shrinking vols in the below-stated options strategy.

If you ponder upon cost effectiveness and wouldn’t like to divert exposure, we advocate buying USDJPY 2w/2m put ratio back spread strikes 107.771/105.515 (2 lots), (vanilla: 0.75%, spot ref: 107.166). A 2:1 put back spread can be implemented by buying a number of puts at a higher strike and buying twice the number of puts at a lower strike.

The short leg with narrowed expiry likely to benefit time decay advantage which in turn reduces hedging cost on the long leg of OTM put.

Currency Strength Index: FxWirePro's hourly USD spot index has shown -63 (which is bearish), while hourly JPY spot index was at -80 (bearish) while articulating at 10:56 GMT. For more details on the index, please refer below weblink:

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

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