I've been pounding the table on this trade for a while now.
And while I may have been a touch early, the thesis is starting to pan out.
When we trade options, we look at the implied volatility of the option to figure out the perception of risk by the market.
And this "risk" will be different across asset classes, even though they can be highly correlated.
The Big Macro Thesis
So far, this summer is starting to pan out just like the past few years. Greece is ugly, risk is blowing out in sovereign swaps, and that's helping to bring weakness into equities as investors go towards "safe" assets, like treasuries.
Shopping for Risk
Because of this heightened risk, the VIX has seen a strong rise after getting very low in march. The closing spot VIX from Tuesday was 19.05, and the VX futures are working off their contango from the past 6 months. However, relative to realized volatility the premiums are awfully rich.
But if this volatility is driven by euro-related news, how are $FXE options faring? We can look at EVZ, which is the VIX for the euro:
Quite honestly it hasn't budged, and a euro crisis would most likely have $FXE options more responsive than $SPY options.
It's a very simple trade:
Buy volatility in the Euro
Sell volatility in equities
This can be accomplished a few ways. For equities, Jul iron condors in $RUT make pretty good sense here.
For the euro, a simple straddle buy would work. For a more advanced play, a time spread sale in /6E options would benefit from a relative rise in vol on the near term options, which would happen if we get a fast move.
It may seem like this trade will at best be at breakeven.
But remember, this is also a vol play. If the Euro starts getting loose to the downside, both options on your straddle will run higher.
And as it stands right now, the premiums are running way too hot on the RUT relative to the volatility.
What do you think? Good trade or full of it? Let me know in the comments.