Notional Exposed: Usd 150MM
Benchmark: 100% hedged
Spot at inception: 1.0968
Maturity: Oct 3rd 2019
Forward rate at inception:1.09969
Cost of forward: 0.26% monthly
Sell EUR Call USD Put in Usd 75MM at K=1.1100, Vol 5.98%, Premium: Eur 217k
Sell EUR Put USD call in Usd 75MM at K= 1.0750, Vol 7.08%, Premium: Eur 96k
Sell Usd 150MM at Fwd rate 1.09969
Premium from options: 0.23% monthly or Eur 313k
The strategy will deliver positive return against the benchmark (better settlement results) at maturity, if Spot rate terminates between 1.0700 and 1.1150. The best return would be 0.23% for the spot at any rate between the two breakeven points.
Should the spot reach either of the strikes levels 1.0750 or 1.1100, we will execute the first stop loss action buying/selling Usd 35MM at the forward level. This action will defend and expand the profit territory to 1.0670 and 1.1200 at expense of reducing the profit to 1.0840 and 1.1000 if the stop hits back after igniting the first stop loss.
The first stop loss action could also be a reestructuring of the original options depending on the type of spot movement and other considerations given market situation at the time.
Market Situation and events ahead:
The FX market continues to be trapped between two important drivers: the commercial fight between the U.S and China with collateral damage reaching Europe, and the evolution of the Brexit deal. Both drivers have immediate consequences for the U.S and the EU economies, and the reflection in the currency pair price is clear. In between, the monetary policies from the ECB and the FOMC are reacting to incipient fears of a sharp slowdown in global economics, especially on the manufacturing sector. Volatilities have come up from years low, and spot level is diving below 1.1000 level for the first time since April 2017.
ECB meeting is on September 12th, and FOMC meeting is on Sept 18th. (BOE & BOJ on Sept 19) Both Central Banks face big pressures from markets and politicians to further accommodate policies to avoid a drastic correction in asset prices. ECB is facing more pressure given its economy is in relatively worst situation compared to that of the U.S. FOMC meeting pressures have more to do with maintaining its independence from the U.S Administration, and any cuts may be viewed as hawkish cuts as it was with the last meeting decision. The USD reacted to the upside.
We advance a month of stable volatility, with Central Banks delivering the minimum to alter markets too much, and with spot within the levels designed in the strategies given the lack of confidence on sustained positions. The USD looks healthy, but overbought, and it is not where the US administration would like to be, so expect talking it down. Brexit resolution is still far from our maturity date so we expect no more than headlines noise. A rapid and consistent movement to either side of the spot would need legs that we don’t see now/still in the market.
Nevertheless, we recognise the current healthy status of the USD and have therefore accommodated the strategy slightly in its favour.
Market is short EUR but not in extremes, and lack of bounce from the EUR could add pressure to the downside as positions build up.
We see investors buying US Gov Assets without protection, thus adding fuel to the USD strength, as they normally choose the US assets as safe heaven. 10 Y Treasury dive to 1.48% before recovering to 1.51%. The degree of deterioration in global assets will determine the continuation of such practice.
Levels to watch: 1.1000-1.1030 now resistance, 1.0850-1.0930 acting as support zone.