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Digital option strategies attractive as eurozone bailout dust settles

Investors may find digital options strategies offer an attractive return in the wake of the latest eurozone bailout, as heightened euro/dollar volatility has made such strategies, which effectively mean selling implied volatility, attractive, strategists say.

Last week’s deal led to a relief rally in the euro, with the single currency gaining two cents against the US dollar to rise above 1.44 in Friday (July 22) trading. The deal – in which a bailout package of €109 billion was agreed by eurozone governments with a voluntary private-sector contribution of up to €37 billion – probably leaves the market watchful on implementation over the coming weeks, and the euro has accordingly been range-bound.

While the cost of euro/dollar options has spiked, traders still stand to profit by employing double no-touch strategies, says George Saravelos, G10 strategist at Deutsche Bank. The market’s cautious welcome of the Eurogroup’s plan should play into the strategy’s hands, he suggests.

The pairing has probably touched its highs and lows for the year, he tells EuromoneyFXNews, and uncertainty on both sides of the Atlantic should leave trading range-bound for the rest of 2011.

Saravelos recommends short option tenors – between one month and six months – owing to the difficulty of forecasting the US and eurozone fiscal pictures beyond the medium term. Strike prices are more difficult to set, strategists say, because the range has fluctuated so heavily in recent weeks.

As an example, an investor wanting to pay a 20%-of-face-value premium, to receive a 100% payout, over a three-month period, would have barriers at 1.3750 on the bottom side and 1.5050 on the top side of the range, based on a spot rate of 1.4400.

For the past three months, EURUSD has traded between 1.4700 and 1.3800. For the year to date, the range has been wider, between a high of 1.4883 in May and a low of 1.2930 in January.

Despite the market’s apparent willingness to allow the bailout time to bed down, the implications of a failure remain high, Saravelos warns. Implementation risks are large too, with general market agreement that Greece is likely to be adjudged in default at least temporarily. Moody’s downgraded Greece to CA, one notch above default, before today’s European open.

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