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    Buy USD/CHF volatility against EUR/USD volatility – SocGen Sandeep Kanihama

    Olivier Korber, Research Analyst at Societe Generale, suggests that an expensive and asymmetric spread EUR/USD 3m vol is trading about one volatility point above USD/CHF 3m vol, the widest spread since 2011 and this expensive market pricing is not sustainable.Key QuotesThe spread widened post the UK vote, as EUR/USD moved more than USD/CHF. Both vols subsequently fell, but the spread is still elevated, which seems an anomaly.The implied vol spread surged in following the spike in the realised volatility spread. While the 3m realised vol spread is elevated, it is not as high as it was last year when it spent some time above 1 vol, while the implied spread remained capped below 0.5 vols.USD/CHF volatility can be seen as EUR/USD volatility with a tilt of CHF risk. Unlike the other two, EUR/CHF volatility usually trades at a large premium above its realised volatility, but this premium recently contracted, suggesting that CHF risk has become surprisingly cheaper. The adjustment would lift USD/CHF volatility higher.With its relative value profile, the EUR/USD vs USD/CHF vol spread is asymmetric and is likely to perform in various market scenarios. 1/ More risk aversion should support both vols, but the spread is already extreme and the CHF should outperform as a safe-haven currency. 2/ Less risk aversion should continue to pressure both vols, with EUR/USD catching up with the already-lower USD/CHF volatility, as CHF risk would stay contained.Expression: Long/short of volatility swapsAs a pure volatility trade, we recommend getting a pure volatility exposure via a long short of volatility swaps. It allows for getting rid of systemic delta hedging and more generally of most of the gamma risks. The pay-off of these instruments depends on realised volatility but their market to market (vega) is sensitive to implied volatility as well.Mechanics Long USD/CHF vs Short EUR/USD 3m volatility swapsIndicative bid: Receive 0.7 vols We expect the vol spread to converge towards a flat level. However, past patterns suggest that the realised vol of the spread could exceed 0.7 vols. As such, we recommend unwinding the position before the expiry as soon as the net profit exceeds 0.5 vols.Risks: Further divergence between EUR/USD and USD/CHF volatility A spread of volatility swaps is exposed to the volatility differential between two currency pairs. Investors holding the position until the 3m expiry face unlimited losses if the realised volatility between EUR/USD and USD/CHF eventually exceeds 0.7 vols.”

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