Foreign exchange options strategists are pitching volatility trades, rather than directional trades, until they get more information about the duration and likely outcome of the Iraqi conflict, according to London-based strategists.
Deutsche Bank and Lehman Brothers are both advising clients to examine volatility plays. Giovanni Pillitteri, v.p. in foreign exchange structured trading at Deutsche Bank in London, is taking the view that volatility will fall as the war progresses and recover after the conflict, as it did during the 1991 war. Therefore, he is telling investors to sell front-end volatility and buy back-end volatility in the dollar/yen currency pair. For example, one-week implied volatility is trading at 10.75% and the one-year is trading at 9.4%. He chose this pair because there is both limited downside, as The Bank of Japan has set a threshold spot level at JPY116.50, and a limited upside, as investors are shying away from buying greenbacks.
Lehman, however, is pitching trades that are long volatility because of the belief that risk aversion has not yet registered with investors. It is recommending clients buy volatility in one-month U.S. dollars/Swiss franc and sell three-month volatility. Anne Sanciaume, foreign exchange strategist at the firm in London, said this is taking the view that the currency pair will be shifting rapidly in the short-term, but three-month volatility will be more subdued.
