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The Eurozone Risk Measurement You Must Watch

Domestic equity markets are well off their premarket lows in spite of fears that more political risk out of the Eurozone (EZ) may give rise to a risk-off market.

It's important to focus on overall "risk metrics" to get a feel as to whether the EZ will continue to be a systemic risk to equities.

The most widely discussed readings stem from European bond yields, namely Italian bonds, which are currently running at the highest yield since the EZ was formed.

We could also view sovereign credit default swaps (CDS) as another risk gauge.

I think that can all get very complex as too many data points can create too much noise.

One Signal to Rule them All

When it comes down to it, where will we see this EZ voodoo reflected in the market? In the currency of course-- $FXE.

The wonderful thing here is that $FXE has options, and we can measure the perception of risk on these options by watching $EVZ. Here is a weekly chart:

Since the spring, $EVZ has been on a steady uptrend, as the fears of Euro volatility continue to be priced into $FXE options. It reached a high that breached the levels seen from the last time we had Euro issues back in 2010.

Note that we are still a ways off from getting back to the credit crisis highs, and the odds of that happening are pretty low, unless we start seeing a run to parity on the $EURUSD cross.

What it Means for Equities

It all comes down to the perception of risk. If the issues in the EZ are resolved or at least pushed out to a further date, the premia in $FXE options will drop, which will be reflected in $EVZ.

If you want to be bullish on equities, you need fears of EZ voodoo to subside. That means want a change in trend in the $EVZ, and you certainly don't want a move back above 2010 levels.

by Steven Place

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