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Oct. 17, 2012, 11:40 a.m. EDT

Is the euro rain in Spain over?

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About Andrew Giovinazzi

Andrew Giovinazzi was a member of both the Pacific Exchange and the Chicago Board Options Exchange where he made markets in both equity and index option classes. During that period he never had a down year. In 1991, Andrew started and ran the Designated Primary Market Maker post for Group One, ltd in Chicago. In 2001, he co-founded Henry Capital Management. He became Chief Options Strategist and Option Pit Mentoring in the Fall of 2011. Andrew has a Bachelor's degree from the University of California, Santa Cruz in Economics. /conga/trading-deck/bios/giovinazzi_andrew.html 230100
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By Andrew Giovinazzi

Is the Rain in Spain over?

Last week, as I noted the steeper skew in the index volatility, paper was pricing in very large moves in relation to the at-the-money movement. This kept the volatility products artificially high and most of it was doubt about outcomes in Europe. The soft movement since (mostly up) is attributable to ... Spain. After all the bad news surrounding the European Debt crisis, the result is that the solid governments might monetize the weaker ones, similar to what Germany did with East Germany in the 1990s. That worked well, but there needs to be budget conformity to make it work. No cheating like the OPEC cartel. The fact that Spain is looking for aid and a way around its stubborn labor unions is a positive sign. The bond market likes it, too. Moody's found it hard to downgrade Spanish debt if the ECB is just going to buy it up. Where does this leave us?

Since most of my option analysis revolves around volatility, the low numbers in the Currency Shares Euro Trust /zigman2/quotes/208198139/composite FXE -0.84% have kept my attention. Implied volatility is around 8.5% in the FXE which is near the low-end of the range for the last year. Even after it rallied Tuesday, implied volatility rose . That was a bit surprising since generally better news should compress volatility levels. All the option series below in yellow show a slightly higher rise in implied volatility than the day before.


3D Charts by ORATS/Aqumin

There are a couple of factors in the euro's rise. Heavy short interest (the FXE is hard to borrow) and short-covering almost always makes stocks more prone to upside covering surprises. The sentiment about the demise of the euro has been so bad that any upside now will show up as a gap (as it did this morning).

If Spain takes the bailout, we could see a nice pop to new highs for the year. The timetable for the bailout request (not looking for the final terms) should fall in the Nov. cycle. The potential trade for this is a skewed strangle in the November cycle that buys the FXE Nov 130 call and for protection buys the Nov 127 or 128 put. Close the trade on a move past $132 in the FXE.

Disclosure: Mr. Giovinazzi has an FXE position.

Follow me on twitter at @optionvol

US : U.S.: NYSE Arca
$ 103.50
-0.88 -0.84%
Volume: 104,367
Jan. 27, 2022 4:10p

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