We all know that Japan has some serious macro issues. While it has not hit the mainstream press as of yet the massive government debt load, large budget deficits, short term debt maturities, aging population and eroding trade surplus make for a potential hyperinflation and/or collapse in the yen. I have seen numerous efforts to structure a trade that would take advantage of this event. However, they all have serious flaws; interest rate swaptions have exchange rate risks and even if you "quanto" the yen exposure the Bank of Japan might step in and put a cap on rates via monetization; simple puts on the yen have risk related to the dollar not exactly being a bulletproof currency; many of the trades I've seen have one year or less expirations, etc. Yen puts for example are capped by the fact that the yen can’t go to 0. While many people have puts on the yen and some quanto caps (swaptions) in place, I 've put in a lot of work into structuring a trade that might have unlimited upside in the event of a collapse and at the same time does not suffer from the flaws I've seen in more common trades. The trade is to buy a call option on 'gold denominated in yen' with a quanto into the dollar. What this essentially means is as gold goes up in yen terms the yen/dollar relationship is hedged out and the payout from the trade does not have to be converted back from yen to USD, thus insulating you from yen usd exchange rate risk. Additionally, you can structure this trade with a very long expiration; the trade I put on has a 4 year term. It is also 30% out of the money.
The payoff formula is as follows:
USD Notional * ((Gold_Final * Yen_Final)/(Spot Price of Yen Denominated Gold) - 130%) = Payout (if positive)
The calls cost about 20% of notional. So if gold triples in the yen, you make 10x your money in dollars.
If you are like me you wonder the following: what if the yen goes to confetti but so does the USD? What if the Bank of Japan caps rates and monetizes enough to ensure that rates never go higher? These are major issues for anyone trying to put on this Japanese collapse trade. I think this structure mitigates those issues and ensures a huge windfall if Japan has the hyperinflation/monetary collapse some are banking on.
Think a sophisticated democratic economy can’t undergo hyperinflation? From 1981-1985 the Israeli price index went up by a factor of 6,500. If this were to occur and gold simply goes up with inflation in yen terms you would make 32,500x you money in this trade. The Japanese people only hold 1% of their wealth in gold so it may be that people punt JGB’s and run to hard assets like gold which gives you an additional pop. I have put 60 bps of our money into the trade. Amortized over 4 years it costs the fund 15 bps per year. If it hits the Israel scenario, I retire a very wealthy man. I like that bet.