FxWirePro: Banxico Ponders Over undervalued Mexican Peso – Hedging Options Over MXN Appreciation Risks
According to Banxico Governor Carstens thinks that the Mexican peso is undervalued and has room to appreciate. In an interview given yesterday he pointed out that the central bank prefers to use interest rates rather than interventions in order to manage the peso exchange rate.
This is entirely sensible. Interventions rarely lead to a change in direction but only ever slow the pace of a currency move. We think that the peso should benefit from good, albeit deteriorating, fundamental data.
Mexico illustrates decent GDP growth and reasonable inflation dynamics. The only fly in the ointment are potential contingent liabilities and some signs of fiscal slippage.
Indeed, these latter developments were the main reason that Mexico was placed on negative downgrade watch lately by one of the rating agencies. Nonetheless, for the moment we’re fully in agreement with the Governor.
FX Hedging Strategies (USD/MXN):
MXN among few EM currency space typically held in carry basket seem cheap on a real effective exchange rate basis, sell 1M USD/MXN ATM calls vs buy 6M OTM delta calls, use European style options.
1M ATM implied volatility of USD/MXN is perceived to be at 12.70% and it is likely to inch higher in long run (for next 6 months to 1-year span).
With rising volatility gamma adds to the considerable risk and reward profile for both holders and writers. Thus, on a hedging perspective in long term, using gamma factor in order to neutralize volatility factor, debit gamma put spreads are advocated so as to reduce the sensitivity and focus on hedging motive.
Hence, shorting 1W (1%) OTM put option with positive theta is recommended to reduce the cost of hedging by financing long position in buying 1M ITM +0.51 delta put option at net debit to enter into this position.