EURUSD found support after the announcement that Greece will receive a €130 billion rescue deal, but it failed to stage a decent rally amid concerns it might need further financing. Indeed, a leaked “strictly confidential” report prepared for eurozone finance ministers revealed that Athens’ rescue programme was way off track and it might need another bailout once a second was agreed.
“While the upwards move in the EUR describes relief that Greece has avoided a messy default next month, the lack of euphoria in the markets on the news aptly reflects the perception that while Greece has overcome one hurdle, the country’s troubles will continue to play out for years,” says Jane Foley, currency strategist at Rabobank.
Still, the market appears convinced that Greece will avoid a messy default when a €14.5billion bond redemption is due next month, even though obstacles to the bailout package remain.
Focus will now switch to private sector involvement in the deal, and if the participation rate is not high enough this could prompt Greece to implement retroactive collective action clauses, which could lead to a credit event.
Athens is also required to implement a series of prior actions by the end of the month before the package can be approved. The deal also requires parliamentary approval in Austria, Finland Germany, the Netherlands and Slovenia.
Despite these hurdles, markets are priced for a resolution to Greece’s debt problems. This is especially true in the options market, with volatilities down at levels not seen since last summer, prior to the aggressive sell-off in risk sparked by the re-emergence of worries over eurozone sovereign debt.
For investors worried about a possible deterioration in the Greek situation, FX options therefore offer a particularly cheap and attractive hedge.
To evaluate the suitability of various liquid currency pairs as a proxy for further turmoil, Barclays Capital evaluated them based on two criteria: their ability to perform well in light of any worsening of the situation and how cheap they were.
BarCap assumes the most immediate effect of further Greek trouble would be a sell-off in European financial stocks.
The bank therefore gauged the sensitivity of three-month volatility for various currency pairs against moves in the Euro Stoxx Banks Index.
BarCap evaluated the cheapness of the position by the current three-month implied volatility, since the ratio offers an easily calculated measure of the amount of protection offered by an ATM option in each cross per unit of implied volatility.
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Sensitivities of 3M ATM options to 1% fall in EuroStoxx Bank Index |
| Source: Barclays Capital |
“Our analysis suggests that buying downside options of the high-beta currencies against the JPY would be the best way to profit from the downside risks of a potential hard default in Greece,” says Raghav Subbarao, strategist at BarCap.
“From a more fundamental perspective, GBPJPY looks particularly attractive due to the UK’s strong financial and trade links with the eurozone, which would make it especially vulnerable.”
Subbarao notes, however, that the threat of intervention from Tokyo limits the attractiveness of a long JPY position.
“In fact, a sharp appreciation of the JPY only makes intervention more likely,” he says.
“Consequently, for investors who do not wish to be long JPY, our model suggests AUDUSD puts or USDCAD calls as being the most profitable.”
