What are your (FX) options - Trading the EUR/USD with elevated volatility What are your (FX) options - Trading the EUR/USD with elevated volatility What are your (FX) options - Trading the EUR/USD with elevated volatility

What are your (FX) options - Trading the EUR/USD with elevated volatility

Options 10 minutes to read
Koen Hoorelbeke

Options Strategist

Summary:  Amid heightened implied volatility surpassing historical trends and the EUR/USD pair's interaction with the 200-day SMA, we present three tailored options strategies. These setups are crafted to exploit potential volatility normalization and to navigate the currency pair's critical juncture, offering avenues for traders to align with the anticipated directional move.


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What are your (FX) options: Trading EUR/USD with elevated volatility

Introduction

 

In the ever-dynamic forex landscape, the EUR/USD pair currently presents a compelling narrative: implied volatility has eclipsed historical levels (see chart below), hinting at a ripe opportunity for premium sellers. This divergence suggests that the market is bracing for movement, with implied volatility possibly poised to retreat to its mean, offering a strategic edge to those ready to capitalize on this volatility contraction.

Simultaneously, EUR/USD's dance around the pivotal 200-day Simple Moving Average (SMA) adds another layer of intrigue. This key technical indicator often serves as a battleground between bulls and bears, potentially heralding a trend reversal. Yet, should the currency pair fail to muster the strength to ascend, it may well signal a continued journey south.

It is against this backdrop that we've tailored three distinct options strategies, each engineered to align with your market thesis. Whether you're leaning towards a bullish reversal prompted by the SMA touch, a more neutral stance expecting stability, or a bearish outlook anticipating further decline, these strategies are designed to navigate the currents of volatility and trend analysis.

Let these strategies serve not just as templates but as springboards for your market engagement, crafted to inspire and adapt to your view of the unfolding EUR/USD saga.

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Important note: the strategies and examples provided in this article are purely for educational purposes. They are intended to assist in shaping your thought process and should not be replicated or implemented without careful consideration. Every investor or trader must conduct their own due diligence and take into account their unique financial situation, risk tolerance, and investment objectives before making any decisions. Remember, investing in the stock market carries risk, and it's crucial to make informed decisions.

In this article we're going to cover the following strategies:

  • Bullish strategy
    • Risk Reversal
        
  • Neutral / range bound strategy
    • Short Strangle
       
  • Bearish strategy
    • Short/Credit Call Vertical Spread
 

Chart of EURUSD, showing the strike levels discussed in the article below, also showing a 1 standard deviation probability envelope

Bullish Strategy

In the first trade setup, showcasing a bullish perspective on the EUR/USD pair, you engage in two actions that result in a net premium received:

Selling a Put Option: When you sell a put option with a strike price of 1.0800, you receive a premium, reflecting your obligation to buy EUR/USD at 1.0800 if the option is exercised. This choice signals your belief that EUR/USD will not dip below this strike price before the option expires.

Buying a Call Option: Simultaneously, you buy a call option with a strike price of 1.0950. This requires paying a premium for the right to buy EUR/USD at 1.0950, positioning you to gain if the pair's value rises above this level.

Financial Implications:

  • Premium Received: You gain a net premium of $24, which is the inflow from the put option you sold.
  • Capital Requirements: There's an initial margin requirement of 10,000 EUR and a maintenance margin of 5,000 EUR, which you need to maintain.
  • Maximum Risk: The maximum risk, theoretically set at $107,976, represents an extreme scenario where EUR/USD plummets to zero, an event that is highly improbable. However, this does highlight that significant market events could have considerable implications on your position. It's wise to consider placing a stop loss on the short put leg to mitigate the impact of such outlier events.
  • Maximum Profit: Your profit potential is unlimited, as the call option offers the possibility of profiting from any rise in EUR/USD above the breakeven point.
  • Breakeven Point: Your breakeven is slightly above the 1.0800 strike price, after considering the net premium received.

To demonstrate what might happen with this strategy, let's look at two scenarios: one where the market moves against your bullish position and another where it aligns with your bullish outlook:

Simulations:

  • If EUR/USD drops to 1.07: You'd face a net loss of $976, factoring in the premium you received against the loss from the put option.

  • If EUR/USD rises to 1.12: You'd achieve a net profit of $2,524, combining the profits from the call option and the premium received.

Strategy Summary:

This setup suits you if you're bullish on the EUR/USD, expecting it to either remain stable or increase. While you accept the risk of buying at 1.0800 if the market falls, the call option gives you a chance to profit from an increase, especially if it surpasses 1.0950. The strategy balances a risk with the put option against the significant upside potential with the call option. Basically you buy your call free, at the expense of taking a loss if you're wrong in your assumption.

Considering the current market scenario, where implied volatility exceeds historical volatility, this strategy might present additional advantages. A reduction in implied volatility over time could further enhance the profitability of your position. Effective risk management, including the use of stop losses, and close market monitoring are crucial for successfully navigating this strategy.

Neutral trading setup: Selling (short) a strangle

In the short strangle strategy outlined by the second setup, you are employing a neutral position on the EUR/USD, where you anticipate that the price will not move significantly and will remain within a certain range. This strategy involves the following actions:

  • Selling a call option: You sell a call with a strike price of 1.0950, from which you collect a premium. This indicates your expectation that EUR/USD will stay below this level until the expiration date.

  • Selling a put option: Similarly, you sell a put with a strike price of 1.0800 and receive a premium, reflecting your belief that EUR/USD will not drop below this level by expiration.

By executing this Short Strangle, you receive a total premium of $444 USD, which represents your maximum potential profit if EUR/USD stays between the two strike prices until expiration. The premium received is of course dependent on the chosen contract size, which you can adjust according to your position size management.

Key Financials of the short strangle:

  • Premium received: $444 USD.
  • Initial margin impact: $10,000 EUR, with a maintenance margin of $5,000 EUR required.
  • Maximum profit: The total premium received of $444 USD.
  • Maximum risk: The risk is theoretically unlimited since the EUR/USD could move significantly in either direction beyond the strike prices.
  • Breakeven points: There are two breakeven points for this strategy. One breakeven point is at 1.07556, which is the put strike minus the premium received (adjusted for the contract size). The other is at 1.09944, which is the call strike plus the premium received (again, adjusted for contract size).

This strategy is particularly effective in a market environment where volatility is expected to decrease or remain low. It's an advanced strategy that requires close monitoring and risk management due to the unlimited risk potential if the EUR/USD makes a strong move in either direction. Implementing stop-loss orders or being prepared to take other mitigating actions is critical to manage the risk associated with this strategy.

Bearish trading setup: Bear Call Spread

In this Bear Call Spread strategy, you take a bearish position on the EUR/USD pair. This strategy involves:

  • Selling a call option: You sell a call option with a strike price of 1.0900, collecting a premium and expressing your expectation that EUR/USD will remain below this level by the expiration date.

  • Buying a call option: To limit potential losses, you also buy a call option with a higher strike price of 1.0950. This option will only be exercised if EUR/USD exceeds this price, which is not the anticipated scenario.

By executing this strategy, you receive a net credit to your account of $131 USD, which represents the maximum profit you will retain if the EUR/USD stays below the strike price of the sold call option (1.0900) until expiration.

Key financials of the bear call spread:

  • Premium received: $131 USD.
  • Initial margin impact: 251.39 EUR.
  • Maintenance margin impact: 251.39 EUR.
  • Maximum profit: The premium received, $131 USD.
  • Maximum risk: The risk is limited to the difference between the strike prices minus the premium received. If EUR/USD rises above the strike price of the bought call (1.0950), this is where the maximum loss will occur.
  • Breakeven: The breakeven point is the strike price of the sold call (1.0900) plus the net premium received per contract size, which is 1.0931.

The Bear Call Spread is a defined-risk strategy, making it clear from the outset what the maximum potential loss could be. It's ideal for a market view where you believe there will be a slight decline or at least not a significant increase in the EUR/USD pair. As always, it's crucial to manage risks effectively and have a plan for potential market moves that go against your position.


Conclusion

In this exploration of EUR/USD options strategies, we've highlighted three approaches for different market conditions. The Bullish Risk Reversal is ideal for traders betting on the pair's rise, offering premium gains alongside upward potential. The Short Strangle fits a low price-volatility environment, where profit comes from the pair's stability. The Bear Call Spread is for those expecting a flat or declining market, minimizing risk while aiming for a defined profit.

Each method balances risk and reward differently, from the Risk Reversal's limitless earning potential to the Short Strangle's premium in a steady market, and the Bear Call Spread's managed risk in a downturn. These strategies cater to diverse trading styles and risk profiles, underscoring the need for tailored risk management in options trading.


Options are complex, high-risk products and require knowledge, investment experience and, in many applications, high risk acceptance. We recommend that before you invest in options, you inform yourself well about the operation and risks. In Saxo Bank's Terms of Use you will find more information on this in the Important Information Options, Futures, Margin and Deficit Procedure. You can also consult the Essential Information Document of the option you want to invest in on Saxo Bank's website.

This article may or may not have been enriched with the support of advanced AI technology, including OpenAI's ChatGPT and/or other similar platforms. The initial setup, research and final proofing are done by the author.

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