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Derivatives

Firms Pitch FX Trades In Response To Equity Weakness

Bear Stearns and Lehman Brothers are pitching options trades which take a view on the severe drop in U.S. and European equity markets last week. Lehman is recommending a trade which is bearish on the Aussie dollar because it believes the currency tends to fall when there are uncertainties around global growth, since Australia is an export-driven economy. Bear Stearns, however, is suggesting a trade that predicts the U.S. dollar will weaken against the euro because of equity weakness, as well as other factors.

Eric Ohayon, head of fx structuring at Lehman in London, said over the last three years many of the dips in the level of the Dow Jones Industrial Average have been associated with drops in the value of the Aussie dollar relative to the greenback. Since this has not occurred in the recent sell-off, the currency pair still has room to fall, he said. Specifically, the firm is recommending that clients buy a two-month Aussie dollar put/U.S. dollar call at a strike of USD0.5375. The trade was designed when spot was USD0.5430. Because the premium on this trade is high, the firm is also recommending that investors sell a 1.5-times leveraged call spread--selling an Aussie dollar call at a strike of USD0.55 and buying a USD0.57 call. The net structure can be entered at an upfront premium of 25bps.

Bear Stearns believes the U.S. dollar will weaken more than the euro because it has other influences that are more important than the stock market, such as its current account deficit and the potential war with Iraq. The firm is recommending one-touch euro/U.S. dollar trades because it believes as though the market is underweight euros. "We think the market is underweight... and investors will have to go back in and hedge themselves," said James Fauset, v.p. in foreign exchange at Bear Stearns in London. The firm is pitching a one-month one touch at USD1.025 with a seven-to-one payout and a two-month one touch at USD1.052 with a 10-to-one payout.

 

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