From the April 2014 issue of Futures Magazine • Subscribe!

Currency volatility trading

A good pair

The situation with yen futures and options, while interesting from a trading perspective, does not involve a pair. A good trading pair should have the following qualities: 1) the two currencies have closely coordinated volatilities; 2) their price movements are closely matched; and 3) the central banks have stable monetary policies that permit low-risk spread trading when the currencies vary from their usual relationship.

During the past two years, the Swiss franc (CME:S6M14) and euro (CME:E6M14) have been an outstanding example of a forex trading pair. The three points above are supported by the announcement by the Swiss central bank in September 2011 that the franc should not be valued at less than 1.20 euro. “Swiss franc and euro ETFs” (below) shows how well the Swissie has adhered to this objective, as illustrated by the matched price movements of the euro and Swiss franc exchange-traded funds. For more than two years this pair has offered trading opportunities. 

We may look back to November 2011 to see the forecast given by, “Forex calls: November 2011” (below) for options on March 2012 futures. The highest call price curve and the one indicating the most volatile underlying is the Swiss franc. The franc is followed by the Australian dollar, euro, Canadian dollar and British pound (CME:B6M14). 

Just as the Swiss franc is more volatile than the euro, the Australian dollar (CME:A6M14) and Canadian dollar (CME:CDM14) are more volatile than their pair trading partner, the British pound. If it is fair to call major currencies subservient, those related to the euro and the pound are subservient to their respective senior partners.

The senior-junior relationship is reflected in a non-forex pair, gold (COMEX:GCJ14) and silver (COMEX:SIJ14), in which silver futures and options are more volatile than gold’s because silver’s price movements are keyed to changes in the price of gold. In the case of gold and silver, the world’s markets instead of a national central bank create the trading pair. 

“Canadian dollar, British pound ETFs” (below) shows the characteristic paired pricing described for the Swiss franc and euro. The Canadian monetary authorities kept a firm hold on the pound through August 2013. At that time, the currencies separated, with the British pound escalating toward a closer relationship with the euro and the Canadian central bank allowing its currency to slide to a lower level. The combined decisions produced a sharp upturn in the dollar difference between the ETFs. The pair had oscillated within a range of $10, but the difference suddenly increased by another $10. 

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