One of the interesting, or perhaps that should read perplexing, aspects of forex moves in 2018 has been the currency market’s seeming indifference to the Swiss franc as a safe haven, a role that Switzerland’s currency has regularly played in the past in times of international tension. Even as tensions in the Middle East have been ratcheting up this week, the Swiss franc was losing ground versus the euro (EURCHF), hitting 1.1880 on Wednesday, the pair’s highest level since the Swiss National Bank abandoned its 1.20 EURCHF floor in January 2015. There’s an argument that the grind up from 1.1500 to above 1.1800 caught market participants short of EURCHF eventually forcing a degree of capitulation. But even if the EURCHF’s drift higher was in part driven by position adjustment that doesn’t explain why, given their have been a number of examples of material international tension in recent months, the CHF seems to have lost its safe haven mojo. Perhaps the answer lies in the fact that as currency markets, particularly in developed market currencies, have not seen dramatic spikes in volatility, there’s been no particular impulse for forex traders to move into the Swissy. At any rate, analysts at IFR argued on Wednesday that “the probability of EURCHF threatening its former 1.20 floor level before the next ECB monetary policy meeting on April 26 is rising” and “speculators who have not been burned by the cross’ rise may be increasingly tempted to go short EURCHF if it nears 1.20.” Traders will make up their own minds if indeed EURCHF does continue higher but in formulating their own strategies might wish to consider how others may also be behaving. If there is an expectation that 1.18-1.20 will be heavy weather for the EURCHF to move through then it might be logical to assume that spot traders who fade short of the pair up to 1.20 could well have their stops just above that level.
Now apply that same concept to the forex option market. If it’s generally believed that EURCHF will top out between 1.18 and 1.20 then that would be reflected in the price of buying a EURCHF put that would give the purchaser the option to sell the cross at a specified point in that 200 pip range. To deflect the cost, bearing in mind the underlying view would be that EURCHF doesn’t breach 1.20, options traders might sell a EURCHF call at a level above 1.20 giving the buyer of the call the option to buy the cross at a specific level. The net effect is, if the range breaks on the topside, that the person who’s bought the EURCHF put, and offset the cost by selling the EURCHF call, ends up having to chase the spot price higher, on a break of 1.20, in an attempt to buy back the euros that have been sold as a consequence of the triggering of both options. This is not to say EURCHF won’t top out ahead of 1.20. It might well do so. But traders who favour that view should at least consider what could occur if EURCHF does break above 1.20.
Written by Neal Kimberley, External Currency Analyst.