Bloomberg News

Options Most Bearish on Euro Since 2003 as Debt-Crisis Deepens

September 13, 2011

Sept. 13 (Bloomberg) -- Options traders turned the most bearish on the euro this week in almost eight years, signaling the currency may extend its 4.8 percent drop this month, as Europe struggles to stem the sovereign-debt crisis.

The premium for options granting the right to sell the euro over those that allow for purchases reached the most yesterday since at least October 2003, when Bloomberg began tracking the data. Bets on a drop in the 17-nation currency outnumbered wagers on a gain last week by the most since January, reversing a so-called net-long position two weeks ago.

The slide in the euro reflects waning confidence that Europe will avert a Greek default and contagion infects banks, while German growth stalls. ECB President Jean-Claude Trichet, who as recently as June 30 signaled the need for higher borrowing costs, said Sept. 8 that there were “downside risks” to the economic outlook, prompting traders to scale back bets that rates would increase.

“I don’t see any fundamental reason why the downward trend in the euro should stop,” Ulrich Leuchtmann, head of currency strategy at Commerzbank AG in Frankfurt, said in an interview. “It’s a combination of a euro-area debt crisis that’s going into a new round and the impression that the ECB is more willing to play a more proactive role in this crisis and use interest rates to support” weaker economies, he said.

The euro was little changed at $1.3674 as of 11:41 a.m. in New York, swinging between gains of as much as 0.3 percent and losses of 0.9 percent. The 17-nation currency weakened 0.4 percent to 105.19 yen after falling yesterday to the lowest level since 2001.

Risk Reversals

The so-called 25-delta risk reversal rate reached minus 4.33 percentage points yesterday, and was at minus 3.87 percent today. A negative rate signals greater demand for euro puts relative to calls. Calls grant the right to purchase a currency, while puts allow for sales. The rate was minus 1.16 percentage points on Jan. 14.

Euro puts that give traders the right to sell the currency at $1.25 “are in demand,” signaling traders see room for further weakness, Olivier Korber, a currency-derivatives strategist at Societe Generale SA in Paris, said in a telephone interview yesterday.

Morgan Stanley lowered its year-end forecast for the euro to $1.30 today, analysts including Hans Redeker, head of foreign-exchange strategy in London, wrote in an investor note. Nomura Holdings Inc. cut its year-end forecast for the euro on Sept. 8, to $1.30 from $1.40, Jens Nordvig, global head of Group of 10 foreign-exchange strategy in New York at Nomura, wrote in a note.

Bond Yields Climb

Investors sold the euro as government bond yields among the euro-region’s most-indebted nations climbed. Italy’s two-year yields rose to the highest since before the European Central Bank began buying the nation’s debt last month, as concern the debt crisis is worsening sapped demand at a note sale today.

Greek two-year notes slid for a 10th day, pushing yields above 76 percent, as credit-default swaps showed the nation has a 98 percent chance of default in the next five years. Italy sold 3.9 billion euros ($5.3 billion) of five-year notes at an average yield of 5.60 percent, up from 4.93 percent at the previous auction of similar-maturity debt in July. Demand dropped to 1.28 times the amount on offer, from 1.93 times.

Inflation Risks

The euro region’s inflation risks are broadly balanced and no longer on the upside, Trichet said last week after the central bank’s meeting, when policy makers kept the main rate at 1.50 percent. He called for “strong vigilance” on price pressures in June, a term he has used in the past to signal an imminent increase in borrowing costs.

Germany’s economy, Europe’s biggest, grew 0.1 percent last quarter from 1.3 percent in the first three months of the year as the region’s debt crisis weighed on confidence, data on Aug. 16 from the Federal Statistics Office in Wiesbaden showed. The worse-than-expected GDP data add to signs Europe is flirting with a renewed economic slump. France’s recovery unexpectedly ground to a halt in the second quarter, Italian and Spanish expansion remained sluggish and Greece’s economy contracted.

The economy faces “particularly high uncertainty and intensified downside risks,” Trichet said at a press conference in Frankfurt on Sept. 8. The ECB cut its 2011 growth forecast to 1.6 percent from 1.9 and to 1.3 percent from 1.7 percent for 2012. Inflation forecasts were left unchanged at 2.6 percent for 2011 and 1.7 percent for next year. The central bank aims to keep inflation just below 2 percent.

Euro-Dollar Volatility

Implied volatility on one-month options for the euro- dollar exchange rate jumped this week to 17.86 percent, the highest since May 21, 2010. The rate is up from 12 percent at the end of last month, and as low as 9.1 percent this year on April 5. Implied volatility, which traders quote and use to set option prices, signals the expected pace of swings in the underlying currency.

“The options market is more bearish now on the euro than it was in May 2010,” said Korber. “There is a crisis of confidence taking place toward the euro and the political situation in the region.”

Hedge funds and other large speculators’ net wagers on a depreciation of the euro climbed to 36,443 in the week ended Sept. 6, the largest so-called net short position since January and a reversal from net-longs of 2,539 on Aug. 23, data from the Washington-based Commodity Futures Trading Commission showed last week.

--Editors: Daniel Tilles, Dave Liedtka

To contact the reporters on this story: Liz McCormick in New York at emccormick7@bloomberg.net; Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net

To contact the editors responsible for this story: Daniel Tilles at dtilles@bloomberg.net; Dave Liedtka at dliedtka@bloomberg.net


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