The euro gained against the dollar in yesterday’s trading session as uncertainty was not adequately brought under control by a modest recovery in global markets. The EUR/USD was pressured upwards to a three-month high of 1.3333 as investors fled the greenback because of concerns over the Federal Reserve’s possible stimulus slowdown. The newfound “safe haven” status of the longtime laggard is an unfamiliar role, and for good reason. Despite an increase in investor confidence in the single-currency zone, fragility is creeping back into the peripheral nations.
The Eurozone would not stand to benefit from a discontinuation of the American central bank stimulus efforts. Liquidity in global markets has pressured debtor costs and allowed the debt-ridden Mediterranean nations (and domestic entities) to take on cheap debt to the benefit of their restructuring efforts. Was quantitative easing to end in the United States, global credit markets would contract and throw the continuing recovery of these into question. Given investors’ historical trepidation with regards to an uncertain situation in the Eurozone, it seems that a long euro trade could unwind as, or more, quickly than a bet on the relative strength of the dollar were fears regarding the tapering of quantitative easing to become more pronounced. As recent releases of economic data from both the United States and the Eurozone have been similarly optimistic, it seems that these fears may come to a head sooner than expected.
So with downside pressure likely to continue, how can a trader take a speculative view on the euro?
- Trading spot EUR/USD. This is the most direct way to take a speculative view on 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.
- Trade 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.
- Euro futures and options on futures. Provides leverage while still allowing a trader to set up a well-defined risk vs. reward setup.
Using euro currency futures options we can calculate the expected move in the Euro by August expiration. With euro futures trading at 1.3300, the at-the-money straddle is implying a move of .0370 by August expiration. We can use this to calculate a downside target of 1.293.
Now that we have a target, we can set up a trade.
Trade: Buying the 6E Aug 1.3050-1.2950 Put Spread for 0.0024
Risk: $300 per 1 lot
Reward: $950 per 1 lot
This trade sets up for a better than 3 to 1 return on initial investment if euro futures trade below 1.2950 On August expiration.