FxWirePro: German politics on euro - EUR/USD option strips for arresting no USD strength, but EUR weakness

In case Friedrich Merz is elected as party leader of the German Christian Democrats, CDU (and, possibly later, as German chancellor), Germany’s Europe policy would not significantly change. Accordingly, the scenario would not constitute a negative signal for the euro medium to long term. 

Moreover, very far reaching demands on integration, amongst them a pan-European unemployment insurance scheme and a joint budget policy seems to be unlikely. Merz would be unable to get his party to agree to such positions, but it demonstrated that his general direction was pro-European. 

However, if one believes the reports of a German news magazine, Merz has since distanced himself from these comments in internal meetings. One could now assume that distancing himself from these comments is due to his efforts to become elected as party leader in December. Whatever the correct interpretation is, the following applies: the stance towards the European Union of the – as some experts say – most promising candidate for party leadership of the CDU (implying he stands a good chance of becoming the next chancellor) is less clear than anticipation.

Hence, the prospect of a chancellor Merz would therefore be no reason for EUR appreciation.

On top, we see more rumours about quick new TLTRO operations by the ECB. These news flows are damaging for the euro as they challenge the prospect of a normalisation of interest rates in the euro zone. That is the reason why we have been seeing such notable EUR weakness since early September, while dollar index is drifting in sideways (refer above chart) – and why it has been persisting while the smell of a new Italy crisis is in the air. It would be utopian to expect all of this to evaporate into thin air overnight. Until then, EUR can continue its down trend. 

OTC Outlook: Please be noted that the positively skewed IVs of EURUSD of 2m tenors signify the hedging interest of bearish risks.

While the negative risk reversals of 1m tenors indicates bearish risks remain intact in the major trend.

Well, contemplating above-stated driving forces and OTC indications, options strips strategy is advocated on both trading as well as hedging grounds. The options strips strategy which contains 3 legs needs to be maintained with a view to arresting price downside risks.

Option Strategy: Options Strips
Combination ratio: (2:1)

Rationale: Considering the bullish (in near-term) and bearish technical environment (in long-term) and most importantly, the skews in the sensitivity tool indicate hedging sentiments for the bearish risks, these risks are coupled with bearish risk reversal numbers.

The execution: Initiate long in 2 lots of EURUSD at the money -0.49 delta put options of 2M tenors, go long 2m at the money +0.51 delta call option simultaneously.

The strategy can be executed at net debit with a view to arresting FX risks on both sides and likely to derive exponential returns but with more potential on the downside. 

Currency Strength Index:FxWirePro's hourly EUR spot index is showing -86 (which is bearish), while USD is flashing at 115 (which is bullish), while articulating at (10:02 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex