Source: FxWire Pro - Chinese / 26 Jul 2016 10:58:02 America/New_York
MXN has been an outlier in EM this year, having depreciated 7% YTD while the rest of Latin American (ex-ARS) saw record portfolio inflows and FX performances. We still hold a bearish view on MXN, citing current account and capital account under pressure, and US election risk premia notably, that have led the currency to decorrelate from oil prices over the past three months.
Heightened concerns around Mexico’s balance of payment deficit and growth trajectory are evident in USD/MXN vol risk premia, as vols are about 1-1.5 vols rich vs VXY EM on a 2y regression basis. EUR/MXN vols on the other hand, look soft as they are retracing to pre-Aug 2015 levels, and EUR vs MXN implied and realized correls have jumped near their multi-year highs.
This setup gives rise to a relative value opportunity in the class of conditional trades. The above chart illustrates the principle we use to detect such opportunities: given 2 pairs (EUR/MXN and USD/MXN) with highly correlated spot returns, the misalignment between the line of isopremium strikes and the spot returns indicates that options in USD/MXN are overly rich relative to the realized marginal distribution of terminal returns between USD/MXN and EUR/MXN.
Focusing specifically on the half-space of EUR/MXN puts, we find that realized spot returns lie overwhelmingly over the line of isopremium strikes, suggesting that EUR/MXN puts are much likely than USD/MXN puts to end in-the-money in scenarios of MXN appreciation, especially when strikes are chosen sufficiently out of the money (>4% OTMS).
The trade has an implicit short EUR/USD exposure, which could be of interest to investors wary of EMU stress/Fed hikes. And while it is calibrated to the magnitude of spot moves, the trade also stands to gain from range-bound price action or MXN weakening as the decay on the USD/MXN leg should dominate that on EUR/MXN. Ranking combinations of pairs according to their ratios of implied/realised betas, we find that EUR/MXN vs USD/MXN is indeed the standout combination (Implied Beta = 1.1 vs Realised Beta = 0.5), especially in the quadrant of EUR and USD put.© FxWire Pro 2019. All rights reserved. The FxWire Pro content received through this service is the intellectual property of FxWire Pro or its third party suppliers. Republication or redistribution of content provided by FxWire Pro is expressly prohibited without the prior written consent of FxWire Pro, except for personal and non-commercial use. Neither FxWire Pro nor its third party suppliers shall be liable for any errors, omissions or delays in content, or for any actions taken in reliance thereon.