What Euro Options are Telling Us about Spot

The options market can often shed light on spot market activity. Indicative pricing in the options market suggests that while the euro is nearing the highs for the year, many participants seem unusually nervous. Often the options market moves in tandem with spot. So in a rising market, the demand for calls is greater. However, this is not the case presently.

Option theory, put/call parity posits that puts and calls equally distant from the forward strike should priced similarly. To the extent they are not, it reveals a skew or bias in the market. Currently, looking at the benchmark 3-month (25 delta) risk reversal shows an almost 1.2% premium for euro puts over euro calls. This is among the largest skews of the year and levels not seen since last year's Q4 chaos.

Looking at implied volatility itself shows that as the euro has recovered from the $1.4625 low at the start of the month, volatility (three month) has eased from almost 13.5% to below 12% today. Implied volatility was lower at the end of last week, although the euro is higher today. What seems to be happening is that with the euro posed to make new highs for the year, (recently) unchartered waters will be entered and implied volatility may actually remain firm. Here participants may be concerned about a tipping point for the dollar, where up until now the decline has been orderly.

Lastly, we looked at the vol curve (from 1 month through 1 year) and it is relatively steep at about 2.5 percentage points. This would seem to be consistent with a market seeking protection from the risk of significant moves. At the start of the North American session, the euro is encountering offers in front of the $1.5050 area, where option structures are thought to lie. Pullbacks have been generally short and shallow. Initial support is seen in the $1.4980-$1.5000 area. The momentum and the conviction that the Fed will not raise rates any time soon, coupled with the fact that the major central banks continue to provide liquidity liberally, the fundamental force weighing on the dollar persists. At the same time, China's reluctance to move on its currency in any meaningful way, will encourage market participants to continue to believe the euro will absorb much of the pressure.