Euro breakup risk falls to 5-year low in butterfly

Economy Shrinks

The currency bloc’s GDP shrank 0.9% in the three months ended Dec. 31 from a year earlier, the statistics office said last week. That was a fourth quarterly contraction and the deepest decline since 2009.

“The crisis stage in Europe is coming to an end but the debt problem hasn’t been completely resolved,” said Daisaku Ueno, a senior foreign-exchange and fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo. “I doubt that the euro region has recovered enough to embrace both austerity and a stronger currency, so the euro isn’t likely to continue its rally against AAA currencies.”

The currency options market has dialed back perceived risk in the euro to five-year lows by some metrics. The one-year euro-U.S. dollar option butterfly was 0.328% on Feb. 15, and closed at 0.308 on Feb. 4, the least since March 2008.

Implied Volatility

The butterfly measures the gap in implied volatility of out-of-the money options, or those presently with no intrinsic value, and those that would allow investors to buy or sell the euro at close to where the exchange rate currently trades, so- called at-the-money options. The value of the butterfly gets larger as demand to hedge against wide swings in the euro-dollar exchange rate increases.

The three-month 25-delta risk-reversal rate showed a 0.25 percentage point premium for euro puts -- which grant the right to sell the common currency versus the dollar -- over calls on Feb. 1. That was the smallest since October 2009.

Hedge funds and other large speculators have reversed bets on the common currency this year, after their net wagers on the euro’s slide reached to a record in June. The difference in the number of bets large speculators have on a gain in the euro versus the dollar and those for a fall, so-called net longs, was 37,952 this month, according to the Washington-based Commodity Futures Trading Commission data.

As recently as the week ended Jan. 8, there was a net short position, which touched a record level of 214,000 in the week ended June 5.

“People had priced in a currency crisis for the euro and realize now that is just not going to happen,” Eimear Daly, a currency-market analyst at Monex Europe Ltd. in London, said in a Feb. 13 interview. “Draghi put a floor under the currency.”

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