Barclays Capital strategists are recommending 10-year trades playing cheap Nikkei implied volatility off of relatively richly priced U.S. dollar/yen implied volatility.
Min Tang, Asia-Pacific derivatives strategist in Hong Kong, said investors could do this via variance swaps or call ratios. The basic premise would involve going long volatility in equity and short volatility in the currency pair. “While we think that USD/JPY implied volatility richness is consistent across the entire term structure, the 10-year segment is under particular stress due to structured product flows,” according to a BarCap strategy report. “As such, we would prefer shorting USD/JPY 10-year vol against Nikkei two-year, where Nikkei vol liquidity is still good.”
In the variance swap play, Tang said investors would buy a two-year variance swap on the index while selling a 10-year variance swap on the currency pair. In a variance swap, the investor pays a fixed leg in return for the realized variance on the index. Realized variance is the actual volatility of the index each day, squared. “That’s if you can find a variance swap on the currency from a broker at a 10-year maturity,” Tang said.
Since the options market is far more liquid, he also recommended the call ratio strategy for the currency side of the play. It would involve selling two to three calls for every one call bought on the dollar. “This is more of a hedge fund type of trade; they are playing the volatility difference,” he said.