EURUSD: VOLATILITY RISK PREFERRED AS RANGE BRAKEOUT LOOMS

It has been 18 months since EURUSD entered a range trading pattern. From portfolio risk perspective the best risk choice has been 1,11 strike short tail risk. Interestingly volatility of EURUSD pair has been subdued with historic volatility measure in decline pretty much through the whole period. The consequence is that cummulatively a lot of volume was exchanged within a small price range.

 

FOCUS ON LESS LIQUID CURRENCIES

With US election due in 3 weeks the possibility of an election result surprise presents greater than normal chance for increase in price risk in the major pair. In simple terms, EURUSD might start experiencing more decisive trend movements. During 2015 and 2016 focus in foreign exchange markets has been elsewhere. Oil price movements resulted in commodity currencies volatility. CAD for example, has seen much greater price trends, while EUR was not moving much. Furthermore Brexit stole the show from EUR as well. These currencies have a significantly lower market volume share than EUR and USD.

 

BANKS ARE VOLUME STARVED

Generally, EURUSD has the largest FX daily turnover by far. However, because of lack of EURUSD volatility the largest players have not been able to make big profits. Without it, banks need to earn sufficient amounts in less liquid pairs, which is more difficult unless there is persistent driving force providing continuous impulse for strategic players to take action.

Now oil price appears to be much more stable, hence market flow in commodity currencies cannot provide sufficient earnings. Brexit perhaps also cannot drive GBP as much anymore. Actually, if GBP finds natural support and stabilizes, volumes will drop in GBP as well. Gold is not in the spotlight either and along with it CHF is not as hot as it otherwise would be. Yield differentials also appear to be at the end of the trend, even if it is just a mid-term development.

 

STEALTH MARKET REPOSITIONING

Since the range in EURUSD has been so prolonged skilled investors received plenty of opportunity for repositioning without much of noticeable market price impact. This means it is highly probable a lot of market participants could about to receive a wakeup call when king EURUSD will start exiting this long lasting range. When EURUSD pair starts to finally trend to the downside or to the upside this could trigger stop loss orders in great volume. As a result, the pair could then start trending even more strongly. When focus will move back to EUR and USD, banks will receive a long awaited boost.

 

PORTFOLIO RISK MANAGEMENT FAVOURS TAIL RISK

All in all, portfolio risk management now favors 1,11 strike long tail risk. Downside risk to this approach is a scenario where EURUSD continues to draw a tight and sleepy range. Elections can be a great protector against much of this downside as it could trigger the pair to move one way or another. Calculations don’t encourage to expose EURUSD to price risk. Best risk cost optimization therefore exists in discretionarily using EURUSD as an instrument for going long trends, while keeping an aggregate portfolio of structured price risk on other currencies.

Gregor Kozelj
Gregor

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