Is US election risk already overpriced, BOA asks

US election risk premia are becoming richly priced in the foreign exchange markets, according to Bank of America Securities, but may already be overpriced.

Historically most FX vols don’t realize enough to recoup the implied volatility premium around the US election, analysts at the US bank said, in a note dated Oct. 7. “Instead, we see contained volatility as a catalyst for FX carry factor to perform past the election.”

The bank noted that significant risk premium is priced in the foreign exchange markets ahead of the US election, especially in the Asian emerging markets. 

“Here we find that the median major FX pair has priced a 108% premium relative to the average of 2016 and 2020, as measured by the daily bounce in the 2m implied vol 2 months before the US election,” BOA said.

However, EM Asia vols have not performed in the US election since 2012, the bank said, and thus it favors fading implied vol. 

In a benign election scenario, we see USD/CNH spot broadly contained in a 6.85-7.30 range, and strikes at similar levels offer sufficiently attractive premium to vol sellers, in our view. 

“As a result, we think a short USD/CNH strangle is attractive to fade rich volatility premia. The risk to this view would be for larger-than-expected fiscal stimulus in China to generate outsize USD/CNH swings,” BOA added.

AT 04:35 ET (08:35 GMT), USD/CNH traded 0.5% lower at 7.0621.

 

Source: Investing.com