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A Trade in Euro Volatility

From failed moves...

2011 has not been kind to the euro. It failed to retake some key levels and is approaching its 3 month low again:

The big yellow light was that it could never retake 1.35 even with some solid multi day strength. Now that we're back at these levels, we hear grumblings of "austerity" and "parity" once again.

So is there a play here? Well, this is fairly strong technical support so there may be a violent bounce here, or a flush. Either way, a strong move will make sense.

Show me the vol

Fortunately we have the EVZ, which is like the VIX for euro (FXE):

The EVZ has a very strong negative correlation with the FXE, and when it trends, it trends. We were in a range late '09 as it continued to creep higher and higher, retracing nearly 3/4 of the move from the 2008 crash. Then the PIIGS started to fly and the market got all flashy-crashy, causing premiums to spike-- a well time volatility buy produced very nice gains back in April and May.

The EVZ has settled down but it seems as though elevated volatility may come back into the market, both realized and implied-- and there could be  a play here.

The Trade

I like the FXE Feb 129 straddle, which is currently being traded for 5.05 (yesterday's closing price). Efectively what you're looking for here is either a violent bounce off support or a flush to the downside-- a 3 point move in FXE either way nets between a 6-14% return on risk. From there, gamma scalping or other adjustments could be made.

The extra kicker comes is if EVZ starts to pop. The current IV on these options are on average 14%, so if they saw a 2 pt increase in vol, you'd have a minimum profit of 70 bucks, which is about a 14% return.

The tradeoff here is that you will have negative theta, about 5 bucks per day, so if it chops around here or mean reverts, it's not going to be as fun of a play. But at these levels, the risk/reward makes sense.

by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/