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USDTWD hasn’t been able to sustain below 30 (intra-day low of 29.975) and CBC intervention should limit the downside, while volatility and skew are low. We find a downside knock-out to cheapen a USDTWD call is attractive.
The volatility and skew at low end of 2yr range TWD implied vol is among the lowest in EM FX and close to the bottom of the 2yr range, while skew is also very low, making dollar calls relatively inexpensive. The sensitivity of vol to spot moves is higher than other Asia pairs (except KRW), benefiting the structure if USDTWD moves up prior to expiration. Cheap skew improves the attractiveness of the KO structure.
Execution: Buy 3m USDTWD call strike 30.70 knock-out 29.85 (vs 0.49% for the vanilla, spot ref: 30.07) Knock-out provides a 30% discount to the vanilla call option and also substitutes for a stop loss (distance to barrier 1% vs premium of 0.33%) on outright long USDTWD exposure.
Risk profile: Rising equities and trend line support Investors buying a knock-out call cannot lose more than the premium paid. The option will expire worthless if USDTWD hits 29.85 at any time before the 3m expiry. Rising equities or a break of the cyclical low (29.92) could see a test of long term trend line support (29.70).
