This comes when many have tried – and failed – to play the downside break, have become discouraged by the resilience of spot, and the cost of holding downside strikes remains high. This has also been supported by the option market being long gamma, which has further suppressed the trading range of the euro. Risk reversals are now trading slightly lower as a result, with 1M RR at -3.3, down from -4 on November 18, but “there remains good value in some topside euro structures at these levels”, says Olivier Korber, derivatives strategist at Société Générale.
For instance, three-month 1.38 calls would cost about 2.11% at a spot rate of 1.3505, while selling a 1.31 put reduces the cost of the structure to about 0.33%.
“Cheapening the structure by selling a euro short-dated euro put isn’t too risky, when you consider the spot resilience to the eurozone difficulties, but I would advise against selling puts much above the 1.30 level,” adds Korber.
So what could drive the euro higher?
In terms of catalysts, policymakers being forced to agree to the so-called bazooka option is the obvious upside risk for EURUSD, say analysts.
A strong move to substantially increase the firepower of the EFSF, either through increased sovereign backing or through direct access to ECB central bank funds, would provide the necessary backstop to the sovereign debt crisis that would at last calm fears of contagion spreading within the eurozone.
Any such move has so far been met with political resistance, particularly from Germany, but with bond markets visibly losing patience, there is a limit to how long the market will permit policymakers to drag their feet.
“A short-term upside structure is really a play on a surprise move, probably involving the ECB,” says Andrew Cox, FX strategist at Citi. “Any such move would be a big boost in confidence surrounding Europe’s debt crisis and would cause some significant short-covering.”
“However, we’ve also seen that an emerging pattern of any sort of good news, however transient or light that is, can lead to pretty decent squeezes higher,” notes Cox.
Given that the market remains considerably short, positive developments – even minor positive developments – may cause a squeeze up to the 1.37 levels seen little more than a week ago.
Interestingly, it hasn’t just been the short dates that have started to see activity. Traders say there was a large buyer of one-year at-the-money, possibly as large as €1 billion today. Market response was fairly static after the hedge fund paid most of the market, with one-year vols trading up from 15.9 to 16.2, traders say.