Friday, February 20, 2015

Trade Idea: My favorite Grexit Hedges

Things are getting quite edgy in Brussels and today we enter another round of showdown talks, backstairs deal attempts and hard-nosed negotiations. The reason the market has not given the due attention to this latest round of Greek tragedy can be mostly explained by the phrase "been there, done that". If you were bleeding profusely in carry and protection cost back in 2010 or 2011 or 2012, you may very well remember how it all ends. Usually. After a lot of words and diplomacy drama, they finally shake hands and make up. Sometimes the ECB chips in - either with no ELA threat, or "whatever it takes" pledge - and both turned out to be very effective. So far.

So there is, perhaps, no reason to believe this time it is any different. And there lies the rub. The chance of any tail event is probably even smaller than the word "tail" implies. At the same time, no one seems to be prepared for it. So here is my favorite list for hedge that will work in case risks flare up. But won't bleed you to death to carry.

1) In FX, it is the simplest. Short euro (or as Goldman points out, even Eastern European currencies as well). There is a chance euro will come back if talks go successful. But given the low rates and the large ECB QE looming, any comeback will hardly be a trendsetter. 

2) For equities (and for others who prefer RV) buy USD quantoed puts on Euro Stoxx Banks index (SX7E) vs vanilla. This is the trade above, plus a good RV in correlation of EUR/USD vs European stocks, which is at pre-crisis historical low levels with hardly much justification.

3) For rates, Buy 5y or 10y break-evens in Germany vs Italy. That is buy the Germany linker vs nominal and do the reverse in Italy. In bad times during the crisis, the inherent larger credit risks in linker vs nominal blows out, and this spread effectively tracked the Italy CDS during height of the European debt crisis.

All of them cost little to carry, and have huge upside. In brief quite close to a good asymmetric bet. You won't go broke carrying them for a while (and it may need a while. The end game, if there is any, is not happening possibly today, or this week or even end of March). And will pay off handsomely if the Europeans do indeed go for the nuclear option.

Good luck.

No comments:

Post a Comment