Euro area politics continue to be in focus with a Le Pen Presidency in the French elections the main concern, but so far the casualty has been the bond market in addition to the FX markets.

Fluidity in French politics continues to offset the strong Euro area economic momentum, putting downward pressure on yields. We update the scenario analysis for the French elections in light of recent developments.

A scenario of moderate market stress with either Le Pen or a unified left candidate achieving a 30%+ score, vs either Macron or Fillon (or the “Republicans” candidate called in replacement).

In alternative scenario: The acute market stress in a confrontation between Le Pen and a Hamon/Melenchon coalition. Regardless of the probabilities of occurrence of each scenario, we make simple arbitrary assumptions for each scenario in terms of market impact in order to rank the efficiency of vanilla.

Let’s not glance through the above nutshell that inclines the probable performances of various EURUSD options on 25-Apr under these broad scenarios and reports their “hedge index”, defined as the geometric mean of the payout/cost ratios under above-mentioned scenarios (the “bad” ones), as well as their payout/costs under the “relief” scenario of an umbrella of scenarios perceived as benign, where Hamon and Melenchon do not present a unified radical left candidacy, the judiciary and public opinion pressure on Fillon abate and either 1) both Macron and Fillon qualify, or 2) either Le Pen or the left wing candidate gather less than 30% of the vote to face either Macron or Fillon.

Naturally, 2M puts are the most straightforward downside hedges, however, their all-or-nothing nature means that they become worthless if the outcome is benign.

To retrieve the highest hedge index while losing only in moderate proportion on a relief spot rally, one needs to scroll down the list to 6M 40D and 1Y 25D puts. The latter do offer better risk/reward than 1Y ATM puts, which explains why 1Y put spreads disappoint.

On the other hand, 3M 10D puts rank lowest among put options, and 3M 10D calls would deliver the worst overall performance under the considered scenarios.

Interestingly, this ties up with the observation we made regarding the performance of fly vols around Brexit, where we had found that 1Y flies outperformed 3M flies.