FxVol Weekly
28 - Jan - 2022
Last week we were not convinced the AUD was going to break down but we now have a confirmed break in the trendline and a clearly rising actual vol trend.
Our hourly dispersion indicator is as one would expect rising from a low level in both the short and longer-term measures. The odds of the trend continuing and persisting still further are high.
As we pointed out here last week any time you can scoop short-dated CAD implied vols under 6% it usually is a very good deal. Like AUD, CAD short-dated actuals have now broken up to the high end of their range, but unlike the AUD the implied vols are not nearly as expensive on an IV/AV basis.
While one-year CAD risk reversals are not back to their previous cyclical high they are clearly getting expensive.
Because the vol of vol has been so subdued in the back end of the CAD implied vol market, using our percentile rank methodology the 12-month is now starting to look pricey and as you can see from the chart the one-year IV-AV spreads have turned positive. This may be an early set-up for a long-dated one-year butterfly trade. We would prefer to see a pullback in the spot. The bid in CAD has been taken out by the BoC not moving last week. Having said that the BoC is really just delaying the inevitable and once the tightening cycle starts we should see some short-term CAD appreciation, but it may prove temporary as the global growth and commodity price dynamics will prove more lasting.
CADJPY is sitting right on top of the hourly trend line. There is still clear signs of longer-term momentum divergence, so a retest of the 92/93 area in our view would very likely be a good place to establish a CADJPY put spread.
USDCHF is set up to retest the 9350 top, but we are betting that a test of 9450 is within reach.
EUR makes a fresh low but the one-month risk reversal fails to test the most recent cyclical low. This could well be a sign that the dollar's downside momentum is waning. A move to sub-1.10 is certainly possible but whether the dollar can sustain the rally beyond that is questionable. Long term momentum is nearly at the previous cyclical extreme, and 3-month and longer EUR risk reversals are starting to look cheap for EUR calls.
Hourly dispersion is still trending higher and that suggests that the dollar has further to go on the upside.
EURGBP is holding above the long term support and may well be forming a double bottom. Short term actuals here are more subdued. The GBP rally vs the EUR has largely been a function of the UK yield advantage. We remain sceptical of the rally but respect the price action and more so if we can break this important support. Long term momentum signals remain flat. We need more evidence of a bottom before initiating but are of the view that a narrow EURGBP call spread with a roughly 3 to one payout might be worth considering. The fate of the Johnson government is also a contributing factor if there is a change in PMs that leads to a material change in UK fiscal policy or policy re the EU. The latter possibility looks unlikely but could materially change in the next election. In the short term, Conservative infighting is unlikely to be GBP supportive in the near term.
The FX market is clearly not pricing in a hot war between Russian in Ukraine. EURCHF momentum remains negative but the front end of the EURCHF vol curve is basically flat. If this assumption proves correct, and so far our indicators are not conclusive then we could be close to an important EURCHF bottom that will greatly assist in moving USDCHF higher. EURCHF risk reversals are also mostly flat on the week. The market is not showing any signs of fear.
USDCHF daily dispersion is also supportive as we are seeing a rise from the lower bound. This argues well for a test of 9350 and, as noted above the upper bound 9450 previous cyclical top. On Friday we closed just below the triangle formation and a clear break should easily lead to a retest of the 9450 top.
The link above is an interview with the head of Global FX Options at Goldman. It covers a lot of theory but offers some useful rules of thumb when it comes to trading options. There is also a useful discussion of the macro drivers of lower FX vol and hints that this big picture may well be about to change. As we have pointed out here before, there is a big difference between running a portfolio of options at a major bank and doing the kind of one-off trades that we like to suggest here. The discussion about options being overpriced/underpriced is fairly simple and regular readers will note that we tend to fade the market's consensus view. This does not in any way mean the market is inefficient, it is not. FX is probably the most efficient market and along with fixed income provides very salient macro information. But what it does mean is that there are regular re-occurring and identifiable market set-ups that do reflect market mispricings or complacency. In our view, these can be found and exploited. Edge is defined as when the statistical odds are in your favour.
FxVolResearch Ltd operates under an exemption order issued in 2003 by the BCSC. The material in this report is intended for accredited investors or professional FX risk managers, traders, portfolio managers who are familiar with and knowledgeable of FX derivatives, and understand the potential risks inherent in options trading. The material in this report cannot be reproduced or re-transmitted in any format without our expressed consent. 
Research Director
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