Tuesday, November 17, 2015

What the Options are saying about the Euro - BBH

FXStreet (Guatemala) - Analysts at Brown Brothers Harriman explained that even if one does not trade currency options, sometimes insight can be gleaned that help the price discovery process.

Key Quotes:

"Very short-dated options that many observers focus on tracks spot too closely to be particularly useful for our purposes. For this exercise, we look at three-month volatility and risk-reversals.

Three-month implied euro volatility trended lower from early September (when it peaked near 11.65%) through mid-October (when it hit about 9.13%).

"Recall the euro was trading mostly between $1.11 and $1.14. With many doubting a Fed hike at all in 2015, the net short speculative euro position in the CME futures fell to its lowest level since mid-2014.

As the euro broke down, volatility has jumped. The day before the US October jobs report was released, 3-month implied euro volatility reached 12%, the highest since the Greek anxiety in early July. There seems to be a couple considerations at work. First, by breaking below $1.08, the euro is at levels not seen in seven months. That alone would seem to warrant high volatility.

One might intuitive suspect that participants are buying euro puts, which would help account for the firmer vol. However, the risk-reversals tell a somewhat different story. Recall that put-call parity says that options equidistant from the forward strike should trade for the same price. To the extent they do not, shows a market bias. Three-month euro calls have not traded at a premium to puts since 2009.

In late-June, as the debate over Greece threatened to spur a disintegration of EMU, euro calls for at nearly a 3% discount to puts. As the euro recovered in the spot market from $1.08, the discount for euro calls was reduced to about 0.6% by late-July. Through the China-induced spike in spot above $1.17 in late-August, the discount for euro calls tended to grow, rising to about 1.75% before the FOMC statement on October 28.

However, since then, the discount for euro calls has been reduced. It is currently quoted near -1.18, which is the smallest discount since the ECB meeting. What is happening? To reconcile the increase in volatility and the reduced euro call discount, it would seem investors are buying euro calls for insurance or a hedge on short euro exposure. Sometimes the options market serves as a parallel market to spot. Other times is functions more as an insurance market. Currently the latter is prevailing."
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