By eFXdata — Oct 08 - 04:30 PM
Synopsis:
Bank of America recommends fading the USD/CNH implied volatility risk premium in light of the upcoming US elections, noting that historically, FX volatility has not justified the elevated premiums associated with election uncertainty.
Key Points:
-
Election Risk Premium:
- The current pricing of election risk in both the rates and FX markets reflects a substantial volatility premium.
- Historical data indicates that most FX volatilities do not realize sufficiently to cover the implied volatility premium associated with the US elections.
-
Volatility Dynamics:
- Since 2012, EM Asia volatility has remained rich compared to historical levels, yet it has underperformed in terms of actual volatility realized during US elections.
- BofA anticipates that contained volatility post-election will serve as a catalyst for improved performance of the FX carry factor.
-
Trading Strategy:
- In a benign election scenario, BofA sees USD/CNH trading within a range of 6.85-7.30.
- The bank suggests that selling strangles at these levels offers attractive premiums for volatility sellers, making it an appealing strategy.
-
Risks to the Strategy:
- The primary risk to this outlook is the potential for larger-than-expected fiscal stimulus from China, which could lead to significant swings in the USD/CNH exchange rate.
Conclusion:
BofA's strategy of fading the USD/CNH volatility risk premium is grounded in historical patterns and market dynamics leading up to the US elections. The recommendation to sell strangles at favorable strike levels provides a tactical approach to capitalize on expected contained volatility, although caution is warranted regarding potential Chinese fiscal measures that could disrupt this outlook.
Source:
BofA Global Research