From the June 01, 2009 issue of Futures Magazine • Subscribe!

The euro vs. Swiss: Which will be smiling?

While the EUR/USD is the most popular pair to trade, euro-based crosspairs provide an alternative set of opportunities. Trading the euro/Swiss pair (EUR/CHF) enables traders to bypass the dollar and take a directional view on the Eurozone economy vs. the Swiss economy.

First let’s review some basics of the Eurozone vs. Switzerland. Eurozone real Gross Domestic Product is -1.4 compared to -0.1 for Switzerland; its Consumer Price Index is 0.5% compared to 2.8% for the Swiss and its unemployment rate is 8.9% compared to 3.3%. Despite the weaker numbers, the Eurozone’s central bank has been less aggressive, holding rates at 1.25% as compared to the Swiss 0.25% rate.

The Eurozone economy has entered its worse recession since World War II. The Swiss economy also has been hit with a contraction. The Swiss National Bank intervened in the foreign exchange market to weaken the currency. It fears that their economy will enter a deflationary period. Too strong a Swiss Franc will destroy the export. With a population of 7.5 million, the Swiss economy needs a weaker currency to attract investment. It cannot depend on consumption growth to engender a recovery. The Swiss Franc represents a decision of the trader on whether it will be the Eurozone or the Swiss economy that will enjoy a faster pace of recovery.

The trader needs to assess the risk/reward of a particular trade from a technical perspective. “Big picture” shows the Swiss Franc struggling for most of the year to rise against the euro. It is midway between support at 1.4574 and resistance at 1.5440. If either level is penetrated, the next key support level is 1.4286, the next resistance level is 1.5882. Notice that except for the move in March, momentum has slowed and monthly ranges have contracted. The sentiment is indecisive as to which way to go. To gain an edge in determining a directional view for trading this pair, the options market can help by looking at volatility smiles and risk reversals for the EUR/CHF and comparing it to the underlying spot price.

If the market opinion is neutral, the implied volatility of the call would equal the implied volatility of the put at the same delta (the 25 delta is the standard location for this measure). In the situation where the implied volatility of the puts equals the implied volatility of the calls, the currency pair would exhibit a curve that is called a “volatility smile.”

“Risk reversal” tracks the difference in valuation between the implied volatility of the puts — implied volatility of calls at a Delta 25. The chart covering the past two years shows that option opinion is skewed towards the euro calls vs. CHF puts. The Risk reversal is positive and heavily in favor of the calls. In other words, the market is asking more for call premiums than for puts at the delta 25 level.

While this may be a bit overwhelming for the beginning forex trader, it is important to note that option opinion shapes spot direction. As of this writing, the “Risk reversal” chart is moving opposite spot. This is a rare divergence over the past two years. Taking a cue from the “Risk reversal” chart, the spot trader has a fork in the road. A bullish trade is a bet that the EUR will rise and the CHF will weaken. This works in tandem with the desires of the Swiss National Bank and correlates with the skew in the option market toward euro calls. A bearish trade plays on the divergence being temporary and the spot leading the more likely path. Either scenario can be justified. When either move can happen, we have the makings of a straddle, where a trader buys a 1.50 call and buys a 1.50 put at the same time. This is worthy of consideration for a long-term (six-month) play.

Abe Cofnas is the author of “The Forex Trading Course” and “The Forex Options Trading Course” (Wiley). Reach him at

About the Author
Abe Cofnas

Abe Cofnas is author of “Sentiment Indicators” and “Trading Binary Options: Strategies and Tactics” (Bloomberg Press). He is editor of newsletter and can be reached at

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