We’ve been urging for hedging through “Ratio Spreads” from recent past on the verge of UK polls and just have a look at what has been happening since then.Uncertainty lingering around upcoming elections and investors should not be misjudging the post-elections havoc and see GBP is too expensive for the election and altering growth. GBP/CHF has been an undervalued among the lot in gamma within the GBP cross currency bloc chart. We don’t think it hasn’t been an unusual scenario posting significant risk premium in GBP cross vols in At-The-Money options. The uneven discounting of political risk in GBP crosses is of interest since it creates relative value opportunities.For instance, GBP/CHF vols are cheaper relative to GBP/JPY in a classic gamma spread. A common GBP leg across both pairs removes any systemic UK exposure, leaving the spread to reflect an idiosyncratic pricing anomaly.We are also comforted that the direction of the spread agrees with the increased jump risk in CHF crosses following the SNB depeg earlier in the year as well as the current two way volatility in EUR, while the passage of BoJ event risk renders GBP/JPY vol more or less toothless and almost entirely reliant on GBP factors to justify current pricing.Hedging Insights:Let’s suppose we will utilize ratio call write strategy as our core position. In this example, we take options at a lower strike price than that at which they are sold. For example, if we buy the calls with a $50strike price, we will sell the calls at a $65 strike price. Of course, we will not just perform a regular ratio call write strategy. We will adjust the ratio at which we buy and sell options to materially eliminate the net gamma of our position.In a ratio write option strategy more options are written than long positions. Thereby some options are sold “necked” and this is intrinsically risky. The risk here is that if the underlying currency rallies enough, the position will lose money as a result of the unlimited exposure to the upside with the naked options. By reducing the net gamma to a value close to zero, we eliminate the risk that the delta will shift significantly assuming only a very short time frame.
The material has been provided by InstaForex Company – www.instaforex.com