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August 29, 2012 / redman59

Is Someone Betting Big on the Euro Pullback?

Today while scouring some sites for option trades of sizeable blocks I came across the Rydex CurrencyShares Euro Trust (FXE), the ETF tracking the Euro.  I thought this was interesting given yesterday’s news of Draghi pulling out the Federal Reserve’s annual economic symposium in Jackson Hole, WY.  Then again this is just news and may have no relation to the trade in the Euro that was seen in the options market today.  Today while looking at the TIme & Sales of the Euro a trade came across where a trader looks to have sold the Sept 122 put 4000x and bought the 124 put 2000x for a 0.16 debit, essentially making this a Put Front Spread.  Below is a picture of the T&S of the trade:


You can see that the Sept 122 put was traded at the mid-price making the sale speculative, but when I see a block like that trade where the two opening transactions can be matched I assume that they were sold.  To further verify my thoughts I plug it into a Risk Profile to see if the trade makes sense and lines up technically.  Below is a picture of plugging this trade into the thinkorswim Risk Profile with the following notes:

  • The trader would be assigned (long) 200,000 shares of FXE if it closes below 122 at September expiration
  • The trader would lose a max of $32,000 if FXE closes above 124 at Sept expiration
  • Furthest left red line = lower b/e at expiration (120.16)
  • 2nd from left red line = max profit of nearly $367,000 if pins at 122 at Sept expiration
  • 3rd from left red line = upper b/e at Sept expiration (123.84)
  • 4th from left, furthest right red line = current price of FXE (124.52)
  • From this trade I believe the trader is betting on a pull back in the Euro and a decrease in implied volatility (notice the negative Vega in the Risk Profile).

I then look to my volatility chart to see if this trade makes sense. Note the following on the chart:

  • Dotted and solid lines represent the Upper/Lower b/e and the max profit pin
  • IV is higher than HV (making this trade a strategy a great candidate is it benefits from a drop and price and decrease in implied volatility
  • The profit region of the trade (120.16 – 123.84) is reasonable as it would bring the Euro back into that range

So what can a retail trader do with this information. I really like two options:

  1. Follow the same trade willing to be long the Euro under 122, which doesn’t seem too bad considering it hit a 2 year low-end of July at 119.73.  Also its a nice profit if the Euro pulls back into the range and follows with consolidation.  This trade would benefit from the positive theta and negative vega components if it went in to consolidation and became mundane.
  2. Put on a Butterfly spread.  I really like this strategy as it limits your risk (unlike #1 as you have naked puts) and the greeks benefit the same, just on a different scale.  One trade that I like is the Iron Butterfly.

This trade can be seen below in the Risk Profile and has the following characteristics:

  • Selling the 122/119 Put spread and selling the 122/125 call spread for a credit of 2.26, risk 0.74
  • Captures the same profit zone and widens your b/e’s from the Put Front Spread with downside b/e 119.74 and upside b/e at 124.26 (about a .40c advantage to each side from the Put Front Spread)
  • Maintains the positive theta and negative vega characteristics
  • Below is a picture with the price slices in the same position as in the Put Front Spread shown above (lower b/e, max profit, upper b/e, last price)

This post is meant to be used as a way to use the option order flow and implement it into your own plan.  By looking at what the big money is doing and how they are positioning themselves you as the smaller trader can follow their strategy or as in this case implement a different one utilizing a spread that would benefit in the same way.  Keep in mind that this is speculative and it is how I interpreted the trade that took place.  I am by no means an expert and only have learned through reading and observation, but I have followed similar action and have benefited.  I actually like this Iron Butterfly trade and I will be looking to put it on.  One thing I do like is that it does not require a lot of attention and especially with Sept expiration has a “less monitoring” aspect as the gamma effect has not really kicked in quite yet.  Also if you are interested in the Euro trade alone, Raul3 of the iBankCoin Blogger Network provides some excellent insight to the Euro along with market profile (example post).  As always, trade at your own risk.

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