With the Greenback Gaining, Euro Puts Heat Up

Diving into a $39 million bet on the ailing euro

Mar 12, 2015 at 9:07 AM
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I believe we have coalesced behind an official driver of this week's market unrest. Blame the cratering euro!

I understand the concept that a big move in a prominent asset class can cause a ripple of jitters throughout the marketplace. But practically speaking, it's going to settle at some point. And it mitigates the even bigger fear in the marketplace that the Fed deletes the word "patience" at some point sooner than the market expects (yes, I know that's something too terrifying to contemplate).

Is the Fed really raising rates so fast in the face of a soaring currency? It seems very doubtful.

Speaking of the euro/dollar trade, "Options Action" highlights a big bet that the trend lower in the euro continues:

"In a massive trade just before Tuesday's close, one trader bought 200,000 January 102/94 put spreads on the Guggenheim euro currency ETF (FXE) for $1.96 per share. Since each options contract controls 100 shares, this is a $39 million bet that the euro goes much lower over the course of the year.

Maximum profits of $121 million come with the FXE at 94 by January 2016 -- which roughly corresponds to the euro trading at 0.94 to the dollar, well below the widely watched parity level."

It's certainly an interesting trade. But as always, there are lots of things to keep in mind before taking too much signal from it. We don't know the total picture. Did the same party pair it with a buy in FXE or euro futures, or did it spot itself? In that case, it's more of a play on volatility than direction.

Even if we know the full picture, what does this predict about future price action? Let's say it's straight speculation on further downside. It's consistent with the current direction of the move, thus I'm not sure it's much of a tell. If, instead, someone wanted to plunk down a $39 million speculative bet on a call spread against the trend, I'd view it as a contra-tell on the margins. The greater the demand to bottom-fish an asset, the less likely it's correct, in my humble opinion.

Also, how big is the player? A $39 million bet is indeed a very large investment in an options spread. Unless it's a huge player, in which case it's maybe an odd lot. Suppose it's a huge fund or institution with a billion dollars (or three) at risk of further euro carnage. In that case, the spread isn't much of a bet on anything. We know anyone throwing $39 million at an out-of-the-money put spread is a size player, we just don't know quite how big.

Traditionally, currency moves trend longer than the markets expect. Everyone is looking for euro parity here. But it's really unlikely it gets right there, bounces, and then that is it -- end of story. It's overwhelmingly likely to either never get to parity or go a bit past the station. Volatility is elevated, but it does still seem like a solid idea to own it now that it's very much in motion. Maybe it's just an intelligent play that doesn't have much in the way of directional implications? That's my best guess.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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