FxWirePro: Yen Skews And Risk Reversal Setup – Hedge USD/JPY Via Debit Put Spread

Japanese Yen outperforms in risk-off mood; while BoJ doesn’t cut, doubles asset purchases. The temptation is to be long the USDJPY for now. But with implied vols still elevated and risk reversals heavily favouring USD puts, we continue to look for USDJPY downside.

Earlier this week yen vol curve has inverted the most since GFC and retraced 70% of the 2008 peak, while widening of the risk reversals (in relative terms to ATM vols) has even exceeded the GFC levels. That dislocation has started to reverse. 

Our yen analysts see USDJPY above 100. If not for liquidity constrains a contained yen upside could be efficiently expressed via defensive USDJPY OTM put calendars that utilize the once in a generation skew-vol setup.

We opt for fading the curve inversion via vanillas on the weak side of the riskies to avoid left tail exposure. 

At spot reference: 107.120 levels, we advocate buying a 2M/2w 108.910/102 put spread (vols 8.95 vs 8.55 choice), we would like to maintain the ITM long leg with the diagonal tenors on hedging grounds.

The rationale: The positively skewed IVs of 3m tenors are still signifying the hedging interests for the bearish risks. We see bids for OTM strikes up to 102 levels (refer 1st nutshell).

To substantiate this bearish stance, one can trace out fresh negative risk reversal numbers that have been added to USDJPY across all tenors, this also signals current hedging interests for the downside risks (2ndnutshell).

Alternatively, shorting USDJPY futures contracts of mid-month tenors have been advocated, on hedging grounds, we upheld the same positions, as the underlying spot FX likely to target southwards up to 105 levels in the medium run. Courtesy: Sentry & Saxo