We have seen very strong demand to buy 1 year EUR vol after the 1 year date has rolled over to include the French election next year. The election in 2017 had a lot of uncertainty for the political landscape and we saw some good move in both spot and vol around and after the election. The market is already now starting to position itself for the next election which has resulted in strong demand for down side EUR options in most EUR crosses.
The first chart above shows the EURUSD 9m and 1y ATM vol and the 9m and 1 year risk reversal. We can see the divergence started 2 weeks ago when the 1 year rolled over to include the first possible first round election date. Last week we had another move in 1y vol as the 1y rolled over the be guaranteed to include the first round.
The spread between the 9m and 1y vol is currently trading at 0.40 vol and the spread for the risk reversal is about the same with 9m trading flat and 1y trades 0.40 for EUR puts. The big spread for the 9m vs 1y vol result in a very high forward vol for the election. The 1m forward vol starting in 11 months and expire in 12 months and include the first round of the election, trades just above 10 vol compared to a 6 vol for the 11 months, not including the election.
The second graph above shows the EURUSD spot and 1 month vol for 1 Mar-30 May 2017, including the first round on 23 April and the second round of the election on 7 May. 1 month EURUSD traded at 13 vol before the first round with high uncertainty for the outcome. Spot then rallied 200 pips and vol dropped to 8 vol as the result of the first round left the right wing with a very low probability to win the election.
ERUUSD 1 year vol trading around the mean level when looking at data after the US election where 1 year traded down from 7.0 before the election to a low at 6.0 in February. We think the risk premium is too rich with one year left to the election and see good opportunities to buy short vega directional trades to the downside to take advantage of the high risk reversal and risk premium. Ratio put spreads or Reverse-Knock-Out puts where you sell vol and benefit from the risk reversal offer good value.
For example, 1 year 1.2000 put cost 6.8 vol and you receive 7.5 vol for selling the 1.1200 strike.
Buy 1 year 1.2000 EURUSD put in 1 mio
Sell 1 year 1.1200 EURUSD put in 2 mio
Cost 124 pips
1.2000 strike cost 240 pips
Buy 1 year 1.2000 EURUSD put with RKO at 1.1200
Cost 58 pips
Knock-out options are not available on the platform but offered over voice. Contact your sales or RM representative for requirement and availability in your region.
Spot ref.: 1.2075
If you like to finance the downside strategies by selling calls in the 1 year, you can sell a 1.2650 call against the put spread or a 1.3100 call against the RKO to make the strategies around zero cost. Alternative you can sell 1.2450 or 1.2800 strikes in the 9 months and avoid the election risk to make the strategies around zero cost. The duration and vol is lower so strikes will be 200-300 pips lower.