2016.04.2703:26:00UTC+00Fxwirepro: Usd/jpy Atm Puts Seem Cheaper As Ivs Highest Among G10 ahead of Fomc - Higher Iv Assumes Otm Strikes in Hedging Strategy

USDJPY OTC FX market observation:

It seems that Fed is bothering only USDJPY pair in OTC markets, 1W ATM IVs if this pair is spiking frantically over 17.37%, the highest among G10 currency space.

IVs for next 1 month’s contracts are also reasonably higher at around 11.95% but the same ATM contacts of 1-3 expiries have gradually reduced implied volatilities that is unlikely to evidence any change in Fed’s following more dovish tone and maintaining rate hiking cycle freezed that may hamper dollar's strength in long term future (see and compare current 1w & 1m contracts with 3m-1Y tenors).

While, the premiums of ATM puts are trading just above 9% (9.37% to be precise), thus we these instruments are underpriced when you compare this with IVs and spot FX curves.

Most importantly, delta risk reversal for the pair is still in bears favor as the highest negative values among entire G10 currency space for all expiries. But risk reversals for 1W expiries are showing little strength.

So, it could be interpreted that any short upswings are the best advantage for bears and may be utilized for shorts in hedging strategies so as to reduce the hedging costs. (Compare delta risk reversal with last week).

The delta risk reversal for USDJPY in long term flashes higher negative numbers that means hedging activities are mounting up for downside risks.

The pair is currently to perceive implied volatility close to 17.5% of 1W ATM contracts that would likely decrease in coming days with increased negative risk reversals, thus we recommend deploying short put ladder spreads that contains proportionately less number of shorts and more longs which would take care of potential slumps on this pair and reasonable volatility times.

Overall, OTC market sentiments states that for next 2 months time Yen may pretty much gain out of lots of manipulations and ambiguities are surrounding around dollar.

Reducing Hedging Cost - Use short term upswings to stay short in long term:

So, short ITM put with shorter expiry since implied volatility is inching higher when risk reversals are lesser comparatively to 1M expiries which is favourable for option writers in next 1 week or so.

Thus the strategy would be, go long in 2 lots of put options (1 lots of underpriced ATM strikes of 1M tenors and 1 lot of 1% OTM put with longer expiry per say 2M expiries) and simultaneously short 1W ITM puts with positive theta values.

If you find it to be effective and accurate then, one can even think rising the weights in this strategy to 3:2.