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Forex traders are anticipating a cold and windy winter for the Euro.
Markets are increasingly nervous about the common currency with the resurgence of the pandemic, rising geopolitical tensions and mounting gas supply problems. Risk reversals in the euro and Swiss franc fell below parity on November 1 for the first time in nearly a year – coinciding with a one-month jump in GARCH in the euro and dollar, a statistical modeling technique that helps predict the volatility of financial assets. Then, this week, that cross dropped to its lowest level in six years.
However, it seems that the breakout of the EURUSD pair through the psychological level of 1.15 on November 10th has already caused the options accounts to panic. Euro options turnover has remained high ever since, driven by higher realized volatility and short-term demand as bearish momentum exposes trading barriers.
Average daily option volume reached €22.8 billion last week, according to Depository Trust & Clearing Corp. Puts outnumbered calls by 4 to 3, and more than €9 billion of exotic options were booked during that time. Demand helped push volatility in money prices to a multi-month high and briefly shifted from one-month deviations to the euro’s most bearish since May 2020.
While volatility typically decreases as the holidays approach, the upcoming options expiration calendar and the shape of the yield curve paint a different picture. On November 24, around €4.2 billion of 1.1500 strikes and €1.6 billion of exotic options booked on DTCC will expire, making by far the largest single day of expiration before the end of the year. With the exception of €4.8 billion in exotics that expire after the December Federal Reserve and European Central Bank meetings, there is a relative dearth of expiration.
Free from options constraints, the euro could continue to be volatile as central bank policy meetings approach amid poor liquidity. Divergences are bearish across time periods, so any further deterioration in the point is likely to introduce implied volatility. At the same time, a return above 1.15 will completely change the volatility outlook.
Looking ahead to 2022, traders seem eager to pick up on election risks and price volatility, particularly the potential dovish bias by the Federal Reserve. Even before the euro fell below 1.15, they were exploiting long-term options. The one-year implied collateral of the yen and the euro has moved higher since mid-September – a sign that the low volatility system between carry currencies is shifting. (On Thursday, the one-year implied volatility in the Canadian dollar touched a three-month high.)
Note: Robert Fullem is a foreign exchange and interest rate strategist and writes for Bloomberg. The notes he provides are his own and are not intended to be investment advice
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