Spain’s Woes Could be Your Gain

10/08/2012 9:07 am EST

Focus: OPTIONS

Mark Sebastian

Founder, OptionPit.com

Mark Sebastian of OptionPit.com explains how options traders could profit from the crisis du jour in Europe.

I will be honest,,   I do not spend a lot of time dealing in currency options. For starters, the futures options do not have that much liquidity. This is because most of the volume is traded over the counter. The FXE currency pays a weird dividend and has a management fee. It also is not the most liquid product, although the front months do trade. However, when something gets out of whack, no matter the product, one should trade it.

Take a look at the term structure for FXE:

chart

Seems a bit odd.  Why is November the cheapest option on the board.  It actually makes little sense. For those that do follow euro the Spanish election is on October 21st, after Oct expiration. Many FX experts do not think there will be any bailout sought until that election. At that point the currency could go haywire again. This makes November seem like a buy against just about every other contract month on the curve. This makes several trades seem very interesting.

On the street I suggested a calendar spread. however I think for this blog I would look toward the straddle or if one has a directional opinion similar to Dennis Gartman, I might just simply buy puts in FXE. The IV is so cheap, it is almost not worth the upside risk to be short the actual underlying or the EUR/USD currency.

The Trade

We like buying a slightly OTM put in FXE in November.

chart

We think that even a small incremental move down could pay off for this put.  We also think the vol is so cheap that there will be very little decay in the option for the next week or so.  Thus we are getting 'free gamma' from the FXE Nov put, albeit, because we have a delta, it only really helps us on a down move.

Mark Sebastian can be found at OptionPit.com.

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