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Oct 09 - 12:55 AM

BofA: Fading USD/CNH Volatility Risk Premium Ahead of the US Election

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

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