Lehman Brothers and Deutsche Bank are recommending foreign exchange trades centered around anticipated changes in levels of implied volatility, but the two firms are focusing on divergent currency pairs. Deutsche Bank is pitching a three-month vol swap to take advantage of cable and euro/dollar having different implied volatilities, while typically they trade at approximately the same level. Lehman Brothers, on the other hand, is pitching a longer-term trade that will pay off if dollar/yen implied volatility rises.
Implied volatility has spiked in euro/dollar while the dollar has weakened, but implied volatility in cable has lagged behind, pointed out Giovanni Pillitteri, v.p. in foreign exchange structured trading at Deutsche Bank in London. To take advantage of this anomaly, an investor would buy a three-month vol swap spread in which it buys the cable risk premium--which is implied vol minus actual vol--and sells the euro/dollar risk premium, Pillitteri said. Currently the spread between cable three-month implied vol and actual vol is 1.45% compared with a spread of 3.57% between the euro/dollar equivalent. The trade pays out if implied cable vol rises relative to euro/dollar implied vol, Pillitteri explained.
Lehman is pitching a one-year volatility forward where the investor agrees to buy, in a year's time, an at-the-money forward straddle--buying a dollar put/yen call and a dollar call/yen put, said Anne Sanciaume, foreign exchange strategist at the firm in London. Currently dollar/yen implied volatility is trading at 9.55%. Sanciaume explained the motivation for the trade is that last year implied vol was at historical lows in that currency pair and it is expected to rise this year. In addition, a conflict in Iraq could increase risk aversion and cause implied vol to spike.
