BLBG: Sell Dollar-Yen Strangle Options as Volatility Falls, RBS Says
Traders should sell out-of-the-money options on the dollar-yen because the currency pair will remain range bound for three to six months, according to Royal Bank of Scotland Group Plc.
“The dollar-yen is not likely to show a clear trend and remains in the range between 93 and 100, and the volatility is likely to fall again,” Masafumi Yamamoto, chief foreign exchange strategist in Tokyo at RBS, wrote in a research report. Traders should sell so-called strangle options on the pair to benefit from this, he said.
The sale of a strangle involves selling a put option with a strike price below the current price of the underlying asset and selling a call option with the same expiration date and a strike price above the current cash price. The strategy profits if the price of the underlying asset stays between the level of the two strikes. Calls grant the right to buy, while puts allow sales of the underlying currency.
Investors should consider selling dollar call-yen put options with a strike price at 100 yen and dollar put-yen call options with a strike price at 93, with maturities of three or six months, Yamamoto said.
“The yen may be affected by both risk appetite and Japanese fundamentals, but both of these factors lack the clear backing from flows currently,” Yamamoto said in an interview yesterday confirming the report.
Foreign Inflows
Japanese stocks are still relatively expensive, so an improvement in the economy isn’t likely to invite large foreign investment flows that would push the yen up sharply, he said. At the same time, increased appetite for risk won’t likely spur a revival of the so-called carry trade, in which investors borrow in yen and invest in assets with higher yields, Yamamoto said.
“The yield gaps between Japan and other countries, the most important component for carry trades, are not likely to widen in a meaningful way during this year,” Yamamoto said.
Implied volatility on three-month dollar-yen options has fallen to 14.8 percent from a high this year of 21.4 percent set Jan. 21, according to Bloomberg data. Selling a strangle option is a bet that volatility will continue to fall.
Implied volatility is a measure of expected price swings and the key gauge of option prices.
The yen traded at 95.87 versus the dollar as of 10:37 a.m. in Tokyo.
