Last week we highlighted the opportunities available in short-dated options and singled out four currencies that were undervalued according to our internal models: AUD, EUR, CHF, and JPY. Here are the results of those recommendations. Based on a spot of .7568 a one week straddle on AUD would be struck at .7567 for a cost in terms of USD points of .0054. At 10 am NY expiration one week later the spot was at .7680 for a net gain of .0113 points or a net gain of .0059 tics or in net in terms of capital-at-risk of 109%. In the EUR the one week straddle would have been struck at 1.1199 off a spot of 1.1195 for a premium cost of .0070points. The spot at expiration one week later was 1.1399 for a total gain of .0204 point or net gain in terms of capital-at-risk of 191%. In the CHF off of a spot of .9691, the straddle would be priced at .9688 for a cost in tics of .0061. At expiration one week later the spot was at .9587 for a gross gain of .0101 and a net gain of .0040 or net return on capital at risk of 66.6%. Lastly, the Yen was basically a wash. Based on a spot of 111.28
strike
would be 111.25 and the cost in would be .75% or approx 83 yen tics. The spot at expiration was 112.03 so the option basically had a loss of .03 yen tics. Basically flat on the week. The above examples could also have been leveraged with strangles, in which case the gain in the EUR would have in % terms been far higher, and the loss
in
the Yen would have been greater. In my view, it is better to leverage these trades and reduce the bet size rather than own the straddles. The reason is that its much more of a leveraged be on the miss pricing but in doing so you have to accept a lower win-loss ratio. As mentioned in early weeks commentary one of the reasons these trades arise is that the market is long the body of the curve and is looking at ways of mitigating the decay bill. As a consequence, the micro-dates get oversold. Secondly, the
market places
too high a premium on what one could call "heavy economic days" for example the US NFP, or the ISM report for example. These dates get bid up far in excess of their real value. As a consequence, a week that is light on economic releases tends to offered too cheaply.
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