Ripples In The Regional Currency Options Market
May 7, 2004
Chinese authorities recently announced their intentions to cool down their rapidly expanding economy. The immediate effect may not be as apparent, but with time it should percolate into the regional markets. The regional currency options markets had been actively trading options on currencies like New Taiwan Dollar, the Korean Won, the Indian Rupee and the Chinese Yuan on an NDF basis, and Singapore Dollar, Thai Baht on a deliverable basis. Most of these currencies do have a decent correlation within themselves and also with the Japanese Yen, which however varies with time.
Over the last year we had seen the Asian currencies appreciate significantly, even with all the buying from the respective central banks. The Bank of Korea and the Central Bank in Taiwan had been very efficient in keeping their currencies weak to support their export-oriented economies. The pressure on China did create the NDF points to move to extreme left on many occasions (CNY being pegged) however the Chinese authorities maintained their stance pretty well, and probably over time will float their currency to a basket of currencies (trade weighted) within a tight band. Last September, the G7 meeting called for a re-alignment (whatever that means) with the economic situation, and we saw usd/yen tumbling down few big figures taking along-with the New Taiwan Dollar and the Korean Won. Since then both the currencies had been range bound as compared to the USD/Yen that went into the uncharted territories below 105.00. The markets had been still pricing the appreciation of these currencies through the risk reversals on the longer end of the curve. At one point investors were willing to pay more than 2 percentage points (in volatility) higher to own the 25 delta Taiwan Dollar call and sell the 25 delta Taiwan Dollar Puts. Similarly, for the Korean Won, it was just one percentage point in volatility. The only one to appreciate convincingly was the Indian Rupee in the real sense. This led the hedge funds to invest heavily on the volatility of the Indian Rupee. They took one year Volatility from 4 percent to 6 percent in matter of few trading sessions. Of course the lack of liquidity of this currency pair did help the price action to gap up fast. To top it, the spot moved from 45.2 to 43.33 and back to 44.75 in just a couple of sessions, making gamma a very precious thing to own for the market makers. However the same risk reversals are trading in this currency pair at par. Hence even with the high correlation amongst each other, we do find a distinct individualistic nature of the regional currency markets.
However the recent moves by the Chinese government to slow down the booming economy might have more long lasting correlated effects than what the financial markets are pricing in. And for sure it will send the ripples down to the regional currency options markets. China has huge trade relations with the neighboring countries as well as the EU and the US. Apart from the US and the EU, the top three countries exporting to China were Japan (roughly 80 billion USD - last 12 months), Korea and Taiwan (40 billion USD each - last 12 months). Most of the regional countries do have a high percentage of exports to china as a share of their total GDP, and it was growing every year. So a deliberate slowdown in this vast economic machinery will send ripples down the other economies, cascading into the exchange rates, and finally to be priced into the regional options market.
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