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Foreign Exchange

Eurodollar options vols spike on Greek concerns; Buying vol on crosses a cheaper hedge

Price action in options markets shows that investors are positioning themselves for declines in the euro, despite rises in the currency against the US dollar in recent days.

Concern over the debt crisis in Greece and other European peripheral sovereigns has fuelled a richening of implied volatility in the euro versus the dollar, analysts say.

One-month EURUSD implied vols were up more than 1.5% over the week to June 17, while one-month 25-delta risk reversals jumped 0.75%, according to JPMorgan, pushing risk premiums to the highest levels since the Irish banking crisis in August 2010, as investors looked to get short the European currency.

“Implied vols from a delta-hedging perspective have become rather expensive but the trade still works to express a directional view,” says Matthias Bouquet, a strategist at JPMorgan. “If you look at the risks priced into the credit markets, euro-cross vols have lagged and are playing catch-up.”

While implied vols on euro puts are somewhat expensive, the move may have further to go, Bouquet says, as many leveraged accounts are still uncommitted after recent poor returns. 

“There is so much uncertainty around Greece – the risk of contagion is never far from the surface,” he says.

Despite Greek concerns, the euro has held firm against the dollar in the spot market in recent days, rising to around $1.4385, from as low as 1.4048 on May 23. It fell in early May from $1.4830 amid rising speculation that Greece might default on its €340 billion of debt.

Pricing analytics suggest that another good way to express a bearish view on the euro would be to buy puts together with or alongside so-called one-touch options against Latin American currencies, and in particular the Brazilian real, Bouquet says.

These options are historically cheap and the spot market is delivering enough realized volatility to make 20% one-touch bets a realistic proposition, he says.

A less attractive way to express a bearish euro view would be against the Swiss Franc, Bouquet adds, where EURCHF vols are exceptionally expensive. Morgan Stanley recommends selling EURCHF vol, in a note.

Morgan Stanley also recommends buying EURBRL vol, with the implied vol much cheaper than realized, though with the caveat that short-dated realized vol is falling.

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