EUR vol too low?

Volatility has been on a downward path for years, and given the persistent weakness in the USD, its no surprise that implied vols are low.

Today we saw 1 month implied vols leg lower into the 5 handle with spot pushing higher through 1.3750, this level of IV has not been seen since mid 2007, however it does seem to have found a floor at around 6%

EUR 1 month ATM IV

Here is a bigger picture, this time with the 3 month Implied Vol, and 60D realized vol (red), both have been storming lower.

EUR 3M IV and 60D realized vol

While we have been firmly below the historic mean for volatility, I think that is about to change. The EURUSD has been stubbornly strong built from a strong, and growing, current account surplus. This being said, even with the bullish factors, there are a multitude of bearish ones, one of which is the diverging monetary policy which should play out eventually - at least when the market moves to pricing from the forward rate spreads as opposed to spot yields (Here)

Now looking at the technical picture we can see the EURUSD is at very critical crossroads. Teetering on the edge of a potentially explosive break higher (and through 1.40, maybe even 1.42)

EUR daily chart, with implied yields in red

While there may not be a clear fundamental reason for a break higher (slowing US?, un-taper?, EZ inflows?) the clear technical picture shows the potential breakout from a >5y trendline from the all time highs. 

Conversely, if we have short end US rates picking up further, the EUR will likely fail to hold the mid 30's and topple over towards 1.28/1.31. 

Where the trade idea comes from is that I see it unlikely that in 3 or 6 months out we will be in the same situation. To me, its pretty binary - we break higher, or we topple lower... Both will be of sizeable magnitude as the importance of the current trendline can not be forgotten.

So this is where it links to the volatility aspect - I can't be sure which way we go from here (my bias is to the downside), but what I am confident is that we will finally see a definitive direction to the EURUSD.

When looking at the vol term structure, we see that, across the curve, Implied vol is very low - but its almost flat out too around 6 months

EUR ATM vol term structure

EUR vol surface

The vol surface somewhat backs up the idea of looking at a purely vol based trade and having no directionality, as we can see there is no significant skew in the smile at the short end of the vol curve - that is to say, puts and calls are of similar expense.

As such, given the above points, positioning "long vol" seems sensible to me. Structured simply via buying a 3 month ATM straddle.

EUR 3M straddle calculator

As we can see from this, the market needs to move about 350 pips either side of 1.3750 to be in profit at expiration in its most simplest form, but also the vega/theta is around 27 days, so if we see a move higher in IV then the trade should profit also. N.B. probs will delta hedge based on short term movements to get the most out of it.

Bonus chart - EUR is starting to move to away from my short term fair value model

Selling GBP against the highs

We've seen the GBP rally over the last few sessions by about 400 points (2.5%) and as we stand at 1.6650 I'm selling at market. This trade is looking for a potential double top at 1.6660 or so, where today, we failed to meaningfully take. Trading on the periphery of a large stops, means the probability may not be as favourable as potentially waiting for the GBPUSD to topple over, but vastly increases the risk:reward profile of the trade.

GBPUSD 4 hour chart w/ stochastics

Furthermore we can see that the market is appearing to be overextended in the short term with stochastics in the low 90's - this is on top of an impressive rally over the past week with the GBPUSD rallying for the 7th straight day, last time it lasted for 8 was over 160 weeks ago. While not itself a reason to sell, the market is running out of momentum (see stochastics) and we are likely to see longs cover after failing to take the 1.67 level.

On top of selling spot, I'm also selling a 1.70 March 6th call for 22 pips premium (mid vol 8%) at spot ref 1.665. Assuming we do roll over tomorrow, at 1.6550 I will look to sell 1.61 puts for the same expiration so as to structure a 3-week strangle, with net premium in around 34 pips. The Vega/Theta for this expiration is around 7 days, so It would be good if implied volatility stays low, but overall this should not be a problem.

First target is down at 1.65, but Ideally, I would like to hold down towards 1.6250

On a side note - today is the first day in a long time where the EURUSD has risen yet my short term fair value model for the EURUSD has fallen, very strange...

ECB and NFP

*ECB LEAVES BENCMARK REFINANCING RATE UNCHANGED AT 0.25PCT
*ECB LEAVES INTEREST RATE ON DEPOSIT FACILITY AT 0.0PCT

The two main headlines to cross the wires at 12:45GMT today. While not a surprise at all, the market reaction was a little mixed. A quick EUR bid, before turning lower ahead of the press conference.

EUR tick

In this time, the DAX had a bit of fun, flash crashing 2% on the front month Futures contract as shown below, while also taking about 30 points from the EURUSD

DAX futures

Then came the Press conference with Draghi, while honestly there is not much new added, it did have a mildly hawkish sense to it. On this, unsurprisingly EUR rate markets where quite active with 1y1y EONIA forwards trading up a couple of basis points. EUR 1 swaps traded fro about 11 down to 3 at one point, cutting the implied yield from 8bps to 4bps, as seen here. The improved EUR rates pushed down the yield differential and pushed up the EUR spot price.

EUR 1 year implied yield (USD - EUR rate)

It has been relatively boring since the press conference, trading very flat around 1.36 EURUSD and 138.5 EURJPY

And as we can see, the EUR lagged the rates post ECB rate decision, as such it was not that much surprise to see a firm bid under the EURUSD, but after the headlines the modelled Rates to EURUSD tracked perfectly. (model based on rate differentials and volatility skews).

EUR vs rate model and spread in bottom pane

BUT, as we can see from the ECB nominal liquidity action is almost certainly needed to avoid short term money market rates from spiking higher, and so there is still potential for the ECB to act in some way or another and remain on a dovish path.

ECB nominal Liquidity

Now looking forward, tomorrow we have the NFP, arguably the most important scheduled data release, and so it is good to see what the market expects of this. What we can see is an expected print of 182-185 based on the median/mean for the Reuters poll.

NFP poll

Some select names see NFP coming in at - 

Barclays - 175K

BNP Paribas - 185K

commerzbank - 200K

Credit suisse - 195K

Deutsche Bank - 200K

Goldman - 200K

Morgan Stanley - 215K

Nordea - 150K

Soc Gen - 290K

What we can see from the options markets currently is the O/N Implied vol in the USDJPY is currently Mid around 19.6, with EURUSD mid around 12.

Pricing this up, as it stands now the Market breakevens at spot +/- 82 pips for USDJPY as seen here.

USDJPY ATM straddle B/E

This means that the market sees about 101 to the downside on a "miss" and about 102.60 on the upside with a strong beat in NFPs

Some other FX ATM breakevens 

AUDUSD - 80 pips (spot 0.8975)

EURUSD - 76 pips (spot 1.3600

USDTRY - 210 pips (spot 2.2070)

So there is definitely some decent expectation going into tomorrow, but as we seen with recent US data, the weather has played a key part in recent data pieces and the Jan NFP will likely be no exception. But bear in mind, given the last NFP reading and subsequent FOMC action, it would appear a major (negative) print would be required for any serious "taper-off" talks.