What's Next for the Euro...
Euro volatility has been in play for the past two month; mid-July EUR/USD traded at 1.0807 lows whilst in August the pair rallied from 1.10 to 1.17 in the space of five days. The Euro was given upward momentum on news that a Greek bailout has been successfully agreed. However, last week saw the US dollar gain ground as fears of a global meltdown spread and investors fled to USD as a safe haven currency.
Looking forward, the Euro could be about to benefit from a changing interest rate scenario. The Fed has repeatedly stated it is ready to raise rates on the back of strong economic data. The Fed principally looks at job creation and signs of inflation. Non-Farm Payrolls (NFP) data, out this Friday, will give big clues as to what the Fed might do next. Market consensus seems to be excluding a hike in September and expects it is more likely to happen later this year. The Fed could still surprise but it would probably take an outstanding NFP number to convince them.
With this new scenario in mind, EUR/USD may be about to continue its recent rally. However, to support an upward trend signs of improved economic activity from Europe are needed. Tuesday’s unemployment rate for the Euro area came in lower than expected at 10.9% from last month’s 11.1%. Today EU Retail Sales came in stronger at 2.7% YoY versus 2.0% expected. Tomorrow we have Euro area Gross Domestic Product (GDP) data indicating economic growth. It will be important to see a GDP number close to expected or higher and a lower number would probably send Euro down again.
The daily-chart (below) reveals strong support around 1.08 and resistance at 1.17. The pair remains above a month-long trend line and currently trades at 1.1230.
How to Trade EUR/USD Price Action
The 1-week at-the-money (ATM) option volatility for the EUR/USD is 12.6%. This means the expected volatility in the coming week is near 0.8% per day (on average). If you believe that the volatility during this week will rise but you do not want to speculate on the pair's trading direction, you may buy a Call and Put option at the same time. The option’s value increases as volatility increases so by buying both options you are also buying volatility in either direction.
The following is an example of a trade set-up on the ORE Web-Platform which will benefit from a rise in volatility with no regards to EUR/USD trading direction:
Buy a Put and a Call both with 'amount to trade' set to 10,000 EUR, strike rate near current market rate (1.1230) to expire in 8 days (next Friday). The total cost to buy this strategy (the ‘open premium’) is 176.47 USD, this is also your maximum risk.
This strategy will generate income as the volatility in the pair increases and as EUR/USD moves away from the strike rate 1.1230 in either direction. For example, if EUR/USD is trading at 1.1700 by expiry the strategy will payout 470 USD. Or, if EUR/USD falls and is trading at 1.08 by expiry the payout will be 430 USD.
Trading a Decrease in Volatility
If you expect EUR/USD price to be less volatile over the next 8-days, it is possible to trade the opposite strategy by selling a Call and Put at the same time. But note that, unlike buying options, selling options involves unlimited risk which you can manage using a stop-loss order or through 'covering' the trade.