Monday, November 16, 2015

"What the Options Market may be saying about the Euro and Yen"

From Marc to Market:
The latest leg down for the euro began in mid-October when the single currency met a wall of sellers in front of $1.15.  Draghi's dovishness at the press conference following the October 22 ECB meeting sent the euro toward $1.11.  The contrasting hawkishness of the Federal Reserve, where the FOMC statement on October 28 specifically cited the next meeting, pushed the euro to $1.09.   The largest rise in US nonfarm payrolls this year saw the euro sell off through the $1.08 area which had offered support in the summer.   Many participants have their sights set on the multi-year low set in March near $1.0460, and parity.  
Even if one does not trade currency options, sometimes insight can be gleaned that help the price discovery process.    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....MUCH MORE