Will the ECB have to join the currency wars?

With last week’s announcement of an unprecedented stimulus program from the Bank of Japan (BOJ) many traders are wondering if the Eurozone will have to follow suit. The BOJ announced a $1.4 trillion dollar stimulus program and a “flexible” inflation target of 2%. With the continuing asset purchases by the Federal Reserve and recent policy shifts in Japan, can the ECB afford to maintain their current policy?

Compared to the U.S. and Japan, the ECB has done little in terms of open market operations to support growth in the still struggling European economy. With policymakers still leaning toward austerity measures rather than accommodative monetary policy the euro currency could become relatively overvalued as the rest of the world continues easing. With French and German exports falling in February for the first time in months, many believe that the ECB can no longer stand idly by.

With economic data in the Eurozone continuing to look weak, many members have been pushing for a more stimulus oriented policy from the ECB. President of the ECB, Mario Draghi, has also taken a more dovish tone as of late, but has been met with resistance. Although major Eurozone leaders continue to favor austerity measures over easing there is a possibility that weak data and other forces will have to force the ECB’s hand.

So how could a trader take advantage of a possible ECB easing?

  1. Shorting spot EUR/USD. This is the most direct way to take a bearish view of the euro, but can be capital intensive and would require a trader to take on a lot of risk when taking a medium- to long-term view.
  2. Short the ETF. The CurrencyShares Euro Trust (FXE) tracks the price of the euro very well, but is the most capital intensive way to trade the euro. The risk required to take a long term trade is also high.
  3. Euro futures and options on futures. Provides leverage while still allowing a trader to set up a well-defined risk vs. reward setup.

With the June straddle implying a move of around .0350 in Euro futures by expiration, we want to look at a trade with a downside target around 1.2750.

Trade:

Buying the Jun 6E 1.285-1.275 Put Spread for .0020
Risk $250 per 1 lot
Reward $1,000 per 1 lot
Breakeven:  1.283

This trade sets up with a huge risk vs. reward ratio and plenty of time for it to develop.

About the Author
James Ramelli

James Ramelli is the Moderator of the Live Futures Options Trading Room at KeeneOnTheMarket.com where he actively trades futures and options on futures while educating members on strategies, setups and risk management. He has a degree in Finance with a focus in Derivatives Trading and Financial Engineering from The University of Illinois and has been trading for five years. James appears regularly on Bloomberg T.V. and BNN and writes a weekly column for Futures Magazine.

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