Options might not be best way to play Grexit
Mounting fears of a catastrophic Greek-euro exit has finally caused the range-bound EURUSD to break below 1.30, but despite tension in Europe reaching critical levels, activity in the options market appears relatively dormant.
One-month at-the-money vols are just over 10%, up from the lows earlier this month but well below the 15-20% levels seen last autumn before the European Central Bank’s first long-term refinancing operation. Since the start of May, implied volatility in the one-month has risen just 1.5 vols. On the surface, the options market might appear to be under-pricing the real risks that could emerge after another unsuccessful Greek election, but it is the continued lack of volatility in the spot markets that is restricting the levels of activity in the options market seen last year.
“Vol is not increasing mostly because gamma is not performing, even on the back of a spot break below $1.30,” says Olivier Korber, currency derivatives strategist at Société Générale.
Long gamma positions reflect bets that realized volatility will rise, but the spot market continues to remain stubbornly stable. Even the move through 1.30 has not been volatile, reflected with two-week realized volatility still below seven.
With this in mind, the options market is actually pricing in the uncertainty ahead with a fairly sizeable risk premium of two-three vols.
So, is there any value in the options market?
“We remain in a paradoxical environment: risk is definitely off, downside gamma is underperforming and the risk-reversal curve has shifted higher for EUR puts,” says Korber.
Risk reversals are bid despite the euro falling with low vol
Realized volatility has fallen, and risk reversals have steadily risen as the market has accumulated more downside positions. Despite the dwindling realized vol, these trades have benefited much more from their vega than what they lost from their gamma, says Korber. One-month risk reversals, a measure of the implied vol of a call option minus an equivalent put option, has risen from -1.3 to -1.9 since the start of the month, a move large enough to offset the low realized vol.
Société Générale says buying risk reversals continues to be a preferred strategy than buying at-the-money vol, in a scenario with more euro downside in sight.
“We’re in an environment where being profitable with volatility trades is difficult right now,” says Korber. “Volatility looks counter-intuitively expensive, but fundamental risks do not prompt us to recommend selling.”
Other options traders echo a similar theme of choosing to take risk off the table, rather than attempt to take positions in thin-value situations.
Put spreads might be a viable strategy for investors with a bearish outlook for the euro, and could be particularly profitable if EURUSD continues to demonstrate its prolonged periods of range-bound movements.
A put spread buying 1.26 puts and selling puts close to 1.20, for example, would offer relatively safe and cheap downside protection, says Korber.
However, the strikes in question will depend on whether an investor is hedging for a continued grind lower in EURUSD as political brinkmanship ensues or whether the aim is to hedge against a disruptive Greek exit or an outright eurozone break-up.
Those wishing to take a position on the latter might find no such trade exists.