Say Squeeze
Happy New Year to you all. With this, the first trading session of 2024, I thought it important to look at an element of potentially complacent pricing that had endured the final trading sessions of 2023. The risk that is presenting itself within EURUSD could be one of the first misallocations to be resolved in 2024. The potential risk within EURUSD centres upon the divergence between the spot and options market pricing within the currency pair. Spot prices and options volatilities rely heavily upon each other. In particular, the price of an underlying currency pair will affect investor demand for the optionality available beneath the currency pair.
However, the causality works both ways. In the case of the infamous short squeeze, it is often positioning within the options market that forces demand into the underlying currency pair. This can cause violent price changes even in relatively benign market conditions. Despite a significant rally in EURUSD in the past six-months, short Euro positions still endure. So-called risk reversals which measure the relative cost of calls to puts in the options markets still show a premium for puts in EURUSD greater than that of calls beyond the 1-week expiry. This shows an options market possibly failing to reflect the grind higher in EURUSD that we have already witnessed.
EURUSD, the most liquid currency pair within the market still trades close to its December highs despite some year-end Dollar buying. A challenge or break of those highs once again could leave these risk reversals vulnerable. In turn this could fuel a short squeeze that would exacerbate any short-term upside in the Euro. With PMI survey data due for many Eurozone nations today, the challenge of EURUSD (options) pricing and market positioning should be high on the priority list to address for 2024.
Discussion and Analysis by Charles Porter
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