Buy Butterfly Options on Ringgit Decline, Morgan Stanley Says

By Ron Harui and David Yong

Nov. 27 (Bloomberg) -- Investors should buy so-called “butterfly” options on the Malaysian ringgit in a bet that volatility will rise by year-end as the central bank tolerates a weaker currency, according to Morgan Stanley.

The U.S. bank forecasts the ringgit will drop 3.5 percent to 3.75 per dollar by Dec. 31 and to 4.00 by the end of June as growth in Southeast Asia’s third-largest economy cools and Bank Negara Malaysia cuts interest rates. A central bank report tomorrow may show gross domestic product expanded in the third quarter at the slowest annual pace in more than three years, a Bloomberg News survey shows.

“The market actually seems to be starting to price increased risk of ringgit devaluation going into the year-end,” wrote Ron Leven, a New York-based currency strategist at Morgan Stanley, in a research note yesterday. “It may be attractive to take advantage of extreme volatility through year-end.”

The ringgit traded at 3.6210 per dollar as of 1:38 p.m. in Kuala Lumpur versus 3.6215 yesterday, according to data compiled by Bloomberg. The currency has fallen 10 percent in the past six months as declining crude oil prices eroded exports.

In a butterfly trade, an investor sells both a ringgit call and a put option with a strike price based on the current spot rate. In the second leg, the investor buys ringgit calls and puts with strikes further away from the current price.

Morgan Stanley recommended buying a butterfly option expiring on Jan. 5 by selling a so-called straddle option with a 3.67 strike price, buying a ringgit put option with a 3.76 strike and buying a ringgit call option with a 3.53 strike. This strategy may give investors a 1.8 percent return, based on an exchange rate of 3.64, Leven said.

Implied Volatility

Investors in a straddle buy a call and a put option on the same currency with the same strike price and maturity. Puts grant the right to sell, while calls allow for purchases.

Implied volatility for one-month dollar-ringgit options was at 13.63 percent. It reached 14.35 percent on Nov. 24, the highest level in at least 2 1/2 years, Bloomberg data show. Dealers quote implied volatility as part of pricing options.

Malaysia’s economy expanded 4.5 percent in the third quarter after 6.3 percent growth in the period ended June, according to Bloomberg’s survey. The central bank will release the report at 6 p.m. in Kuala Lumpur tomorrow.

Crude oil prices have dropped 63 percent since peaking at $147.27 per barrel on July 11, leading to a fall in Malaysia’s exports. The nation’s central bank on Nov. 24 cut its overnight policy rate to 3.25 percent from 3.5 percent, its first reduction since May 2003, citing weakness in exports and the labor market. Policy makers next meet on Jan. 21.

To contact the reporter on this story: David Yong in Singapore at dyong@bloomberg.net; Ron Harui in Singapore at rharui@bloomberg.net.