Lehman Brothers is recommending clients enter bullish sterling call spreads and buy sterling knockout calls against the yen. Anne Sanciaume, foreign exchange options strategist in London, said the bank expects sterling to appreciate to JPY200 by year-end. Political pressure in Japan for a weak yen is mounting, according to Giovanni Pillitteri, foreign exchange strategist in London. Players there are looking for an export-led recovery, he added. While the yen is weakening against a broad array of currencies, the interest-rate differential between sterling and yen is higher than the interest-rate differential between the U.S. dollar and the yen, or the euro and the yen.
Sanciaume suggests clients buy a sterling call struck at JPY185 and sell a sterling call struck at JPY195, both expiring at year-end. Net premium paid for this trade is 0.92% of the sterling notional. Investors win in the trade if sterling goes above JPY186.70. If sterling reaches JPY195 investors receive five times their initial investment. Profit is capped beyond JPY195. Selling the sterling call/yen put at JPY195 generates premium, which makes the trade cheaper.
Another good trade, said Sanciaume, is to buy a sterling call struck at JPY185, maturing at year-end, that knocks out at JPY170. Premium for this option would be 1.03% of the sterling notional. Investors win here if sterling reaches JPY185 without falling to JPY170 beforehand. Adding a knockout feature made the option cheaper, but the level is low enough that the investor has a safety net, said Sanciaume. The same strike call without the knock-out would cost 1.85% of the notional.
Euro/yen spot was trading at about JPY175 when these trades were designed last week.