Back-end (>2Y) EURUSD and EURJPY vols look deep value after the de-pricing of European political risk, and materially cheap adjusted for short-end FX and interest rate vols.

A byproduct of the violent de-pricing of French election risk after the first round outcome is that back-end (1Y-2Y) EURUSD and EURJPY vols have crashed to near 2014 lows (refer above chart). This event-related compression comes on the heels of generalized pressure on long-expiry vols across currencies this year due to a mix of Trump-related risk premium squeeze and vol-supplying hedging flows from Japanese importers, European corporates (typically airlines) and the like.

The portfolio has benefited from these dynamics insofar as it is long EURJPY and long TRYZAR, The former was helped by higher core yields and deleveraging of euro-funded positions in high-beta currencies. But the key theme for the portfolio remains European reflation including a core long position in EURJPY.

As such we remain comfortable with long EURJPY exposure as a core trade on European reflation/ receding political risk.

Please be noted that the above nutshells evidencing OTC indications are quite tricky.

Let’s run you through what does it imply, as the delta risk reversals (RR) of euro crosses (especially in EURJPY) have shown a mounting bearish interest as the progressive increase in negative numbers signify the traction for hedging sentiments for further downside risks in both short and long term. EURJPY is the highly perceived pair to have bearish risks (see for the highest negative numbers among G10 space).

To substantiate this bearish stance, positively skewed IVs of 1m tenors are signifying the hedgers’ interests in OTM put strikes. This implies underlying spot likely plummet further southwards.

Hence, bid EURJPY 3M RR and initiate longs in 2M EURJPY ATM straddles. EURJPY ATM in 60:100:-150 vega ratio.

Please be noted that the above diagram shows that the payoff structure of 1w straddles of EURJPY regardless of swings.