Trade Stategies: EUR/CHF And EUR/TRY

Implied volatility has, in general, corrected lower over the past couple of weeks. However, when evaluated by a Z-score of historical spreads between implied and realised volatility (see page 7), front-end volatilities in general still look expensive, while implied volatility on longer dated maturities looks cheap. Following a period of sharp sell-offs in emerging market (EM), and some commodity currencies, volatilities in the EM sphere remain elevated. Thus, implied volatility in EUR/TRY and USD/TRY trade around the highest levels seen in at least a year but stretched levels are also seen particularly in the front end of the curve in, e.g., EUR/PLN, EUR/HUF and EUR/CZK.

Carry trade strategies have been under pressure recently and despite increases in EM interest rates, carry-to-risk looks less favourable due to the rise in volatility. Our open carry basket (long MXN, HUF, and TRY versus short USD) lost more than 3% in August, while our G10 carry basket (page 13) lost around 1% over the same period.

Trade idea #1: sell 3M 1.2450 (skewed) EUR/CHF straddle
Front-end volatilities in general look expensive and our range-trading monitor (page 10) suggests selling 3M EUR/CHF straddle. Given the geopolitical situation, we prefer to be short EUR/CHF volatility where the SNB-imposed 1.20 floor protects against an escalation of the conflict in Syria.

We already have an open recommendation to sell 3M EUR/CH F1.22 put and buy 6M call (half of the notional on the sold put) at zero cost – see FX Trends: Trust your central banker (20 August) for details. We still see potential for an increase in EUR/CHF in the near term and expect the 1.20 EUR/CHF floor imposed by the Swiss National Bank to remain intact in the coming months. Hence, as an alternative to the 3M/6M strategy, we think a skewed straddle also looks attractive. Specifically, we suggest selling a 3M 1.2450 (skewed) EUR/CHF straddle for an upfront premium of 265 CHF pips corresponding to 2.15% of notional (indicative prices, spot ref: 1.2370). This strategy benefits from the positive option skew (see page 11) and is profitable as long as EUR/CHF trades within the range of 1.2185-1.2715 at maturity (10 December).

Trade idea #2: Enter 3M EUR/TRY risk reversal
TRY has been one of the worst-performing currencies over the past month, when fears of a hard Chinese landing, and not least the conflict in Syria have weighed not only on TRY but on EM currencies in general. One way to position for a near-term improvement in risk sentiment and a possible correction higher could be via a EUR/TRY risk reversal, which utilises the high level in volatility (page 7), a positive carry (page 13), and an attractive option skew (page 11).

We suggest entering a 3M EUR/TRY risk reversal at zero cost by buying a 3M 2.6900 (at-the-money spot) put option and selling 3M 2.780 call (indicative prices, spot ref: 2.6900). However, it should be noted that tail risks on TRY are high and alternatively it could be considered to reduce the risk by paying a premium for the EUR/TRY put option: 3M 2.6900 put option costs an indicative upfront premium of 520 TRY pips. This strategy is profitable if EUR/TRY trades below 2.6380 (breakeven level) at maturity, a level last seen on 21 August.

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