FxWirePro: What do EUR risk reversals and delta hedges offer?

EUR-cross-risk-reversals have understandably re-priced sharply in the direction of EUR calls, especially against G10 commodity currencies that were among the worst performers on the week.

We struggle to see severe dislocations in this space at current levels, with some mild value only in EURCAD 3M riskies at 0.4 which we are not inclined to chase in light of the cheapness of the loonie on short-term models and the potential for an oil rebound in coming weeks that can cap the extent of EURCAD strength. EURCNH riskies (3M 25D -0.05) however strike us as interesting buys.

First, EURRMB has a long history of high correlation to EURUSD which has been formalized since late 2015 by virtue of China’s migration to basket FX mechanism that assigns a significant (16.3%) weight to the common currency; hence EURCNH is a bonafide proxy for expressing a core bullish Euro view.

Second, it offers exposure to CNY disorder without charging a vol premium, making it an excellent hedge against USDCNH carry trades that have been instituted lately in anticipation of an oriental summer snooze fest.

Delta-hedged EURCNH risk-reversals also offer substantial positive carry (options are net costless, the short EURCNH forward delta-hedge is carry positive; refer above chart), hence qualify as standalone bleed friendly risk hedges in vol portfolios.

Please be noted that the above nutshell evidencing delta risk reversal numbers of major euro crosses are flashing up higher negative prints to indicate the mounting hedging interests for bearish risks. 25-delta negative risk reversals would imply that the difference in volatility, and therefore price, between puts and calls on the most liquid out-of-the-money (OTM) options quoted on the OTC market and also implies puts have been in more demand than calls, consequently, the downside protection is relatively more expensive.