Sterling stuck in range again – Capitalize on low vols and 1m skews for certain yields in strangle writing
Sterling constricts in the range: Cable seems to remain in range-bounded trend, it has been oscillating between 1.3300 pivot support and the 1.3550 reaction highs set at the end of November.
Further range trading is expected. Any breach below 1.3300 supports likely to eye at 1.3100-1.3050 levels, otherwise, on the contrary, anything above 1.3550 resistance may see 1.3650 – 1.3680 mark.
This is all within a medium-term range that we expect to remain intact in the coming month(s) between 1.28-1.26 support and 1.36-1.39 resistance.
In a broader perspective, our analysis indicates the bearish trend that started back in 2007 at 2.1160 is in its last sphere. The recent price action enhances the chance that 1.1490 was a major long-term low. Even so, there exists an element of risk of sharp sell-offs on any negative Brexit news.
Comparing volatility across different UK assets yields an interesting view of how different asset classes have been behaving.
Firstly, the current dispersion in equity, rates and FX volatility levels seems elevated by historical standards. More specifically, FX volatility has remained at around average levels over the last five years while rates volatility is currently more than two standard deviations below average levels. Equity volatility is at around one standard deviation below average levels.
Secondly, this dispersion seems to validate the standpoint back in June that FX would tolerate the brunt of Brexit, while equity volatility would remain subdued in sympathy with other equity indices globally.
Let’s have a glance through the implied volatilities of GBPUSD ATM contracts from the above nutshell, IVs of this underlying pair of 1m expiries have been shrinking away among G10 currency segment. These lower volatile conditions are conducive for the option writers.
While the bearish neutral risk reversal of this pair has also not been indicating any dramatic shoot up nor any slumps but seems to be one of the pairs to be hedged for downside risks as it indicates puts have been relatively costlier.
Most importantly, 1m skews have been well balanced on either side, which means FX options players of this pair seem to be interested in both upside and downside movements.
Additionally, please also be informed that the pair’s range bound pattern is still persisting but some bearish candles are indicating slight weakness on both weekly and monthly charts on technical base, (from the last couple of weeks, ranging between upper strikes 1.3465 and lower strikes at around 1.3301 levels.
For now, we could still foresee range bounded trend to persist in near future but little weakness on weekly charts is puzzling this pair to drag southward targets but very much within above-stated range.
As a result, we recommend below option strategies using right options, thereby, one can benefit from certain returns.
Naked Strangle Shorting:
Short 2m OTM put (2% strike difference referring lower cap) and short OTM call simultaneously of the same expiry (2% strike referring upper cap) (we reiterate, the comparatively short term for maturity is desired).
Overview: Slightly bearish in short-term but sideways in the medium term.
Timeframe: 1 months
When you write an option, the seller wants IV to remain lower level or to shrink so the premium also fades away which is what has been happening in this pair.
Hence, writing such calls seems smart choice in tepid IVs on speculative or trading grounds.
Considering above OTC market reasoning, amid prevailing uptrend we think downside risks can also not to be disregarded in the long term, as result we reckon deploying shorts in such exorbitant call options.
Currency Strength Index: FxWirePro’s hourly GBP spot index is inching towards -43 levels (which is bearish). While hourly USD spot index was at -88 (bearish) while articulating (at 06:55 GMT).
Source: FXWire Research