OPTIONS

Everyone seems to have ideas for playing the ongoing drama in the Eurozone. Mark Sebastian of OptionPit.com, offers an angle using currency options.

I am always trying to teach my options mentoring students to find opportunity. The key is to understand what the opportunity, where the edge, and what is are the risk. Take a look at FXE; the IV 30 of FXE just hit a 104-week low.


chart
Livevol® www.livevol.com
Click to Enlarge

Does this mean that the IV is an absolute must buy? That we should be backing up the truck on FXE premium. The short answer is no. The long answer is yes and no. Take a look at this chart from VOLX.US.

chart
www.volx.us
Click to Enlarge

While the yellow line (where we are trading) appears to be a generally lower bound for forecasted realized volatility, notice what happened in the mid-2000. Realized vol completely tanked, and stayed that way for a couple of years. This could happen again, in spite of what many perceive to be a euro headed for disaster. The point is, that as cheap as IV is, and current realized volatility is, it can always go lower, and stay there for a while.

So how do we trade this? It is completely okay to jump in and start buying some premium. However, we are not going to start backing up the truck here. In fact, like the mid-2000's it does not make sense to back up the truck long until vol actually picks up. Here is a smart rule all traders know: don’t buy or sell a lot of premium until someone smarter, and bigger than you does it first. Until that happens, only dip in toes.

The Trade
It still makes sense to be long volatility here in FXE, I would slowly start building a Jan long position in FXE, I think it is an interesting and cheap way to play the fiscal cliff. It also could be a play on the mess in Greece. If the Greeks get their loan, I think FXE makes another run at 130.

By Mark Sebastian of OptionPit.com

Tickers Mentioned: Tickers: FXE

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