FxWirePro: What drives optimal choice between OTM and ATM strikes in put spreads amid bullish/bearish scenarios of NZD/USD?

Bearish scenarios: Expect NZDUSD to slide below 0.67 if:

1) The housing market slowdown becomes disorderly

2) The migration rolls over due to a shift in government policy;

3) NZ bank funding issues intensify, causing the market to question NZ's ability to attract capital inflow.

Bullish scenarios: See underlying spot FX to bounce back above 0.72 given:

1) Fiscal easing and the increase to the minimum wage drive broader wage inflation and gains in household income, boosting the inflation outlook;

2) Falling global term rates take some pressure off local mortgage rates, allowing the housing market to recover.

OTC Outlook and Options Trade Recommendations:

All the factors stated above seem to be discounted in FX options market, please glance through nutshell evidencing IV skews that signify hedger’s bearish interests in next 2-months timeframe. Positively skewed IVs of this tenor signal underlying spot FX is expected to be lowering southwards as the skews have been well balanced flashing positive numbers on OTM strikes.

Also be noted that at spot reference: 0.6978, the 2m skews are targeting OTM put strikes at 0.6750, whereas 2w positive skewness is still showing hedgers’ interest on ATM strikes.

Accordingly, we’ve recommended credit put spreads in order to participate both upswings in the consolidation phase and anticipated downside risks.

We recommend writing 2w (1%) in the money put with positive theta snapping decisive rallies. You could easily make out short legs on ITM puts of narrowed expiries are going worthless considering time decay advantage. Simultaneously, we uphold longs in 2m (1%) out of the money put, the structure could be constructed either at the net credit or at zero cost.

Theta shorts are recommended in this strategy because Theta is not a constant, it changes as the underlying market moves and time passes. Theta is the sensitivity of an option’s value to the passage of time. It is usually expressed as the change in value per one day’s passage of time.

The mounting bearish risk sentiments are observed as you could see the positively skewed IVs in OTM put strikes of 2m tenors (refer positive IV skews indicate the strikes towards 0.6950 which is 50 pips below our forecasts).

The combination of IV 2w/2m skews suggested credit put spreads that have favored to arrest ongoing upswings in short run and bearish risks are to be taken care by 2m OTM longs.