The Rise of EUR/GBP
The Euro has gained significant ground against the GB pound; from a low price of 0.6935, seen on July 17th, the pair has since traded to 0.7420 (high on August 24th). Looking at the daily candle bar chart below, we can see a triangle pattern (black lines) which has formed over the past two weeks. From a technical analysts point of view, a triangle formation is considered as a pause in the market trend and may lead to a continuation of that trend. The continuation signal is given once price closes above the top line of the triangle. It very rarely leads to a trend reversal. If you think the next move for this pair is up, you can either buy EUR/GBP directly in the market or purchase a Call Option which gives you the right to buy EUR/GBP at a specific price (strike) until a future date (expiry).
When you purchase a Call option you pay a premium. This premium is your total risk in the trade. You may profit as EUR/GBP rises above the strike rate and if the pair does not rise by expiry you will lose the premium you paid.
For example, EUR/GBP is currently trading at 0.7300. The below image is a Call option to buy 100,000 EUR/GBP at 0.7350 (strike) over the next week (7-day expiry). It costs a premium of 270 GBP to purchase the option.
If EUR/GBP rises above the 0.7350 strike before expiry on 14th September (at 14:00 GMT) the option will payout and you may profit. For example, if EUR/GBP moves up to 0.7450 the option will payout 1,000 GBP. If the pair does not trade above the strike by expiry then you will lose 270 GBP premium.
If you expected EUR/GBP price to trade in the opposite direct and fall, you can either sell the pair directly in the market or purchase a Put option which gives you the right to sell EUR/GBP at a specific price (strike) until a future date (expiry).
A Put works in the same way as a Call option but instead you have the right to sell rather than buy. For example, the image below shows a Put to sell 100,000 EUR/GBP at 0.7250 over the next 7-days. It costs a premium of 247 GBP to buy this option.
If EUR/GBP falls below 0.7250 strike over the next week, this option will payout and you may profit.
Euro Strength or Sterling Weakness?
Before the recent uptrend the Euro had been in a downward trend which took it from 0.8768 in August 2013 to its most recent low at 0.6935. This happened on the back of better UK Gross Domestic Product (GDP) performance as the British economy has recovered faster than Euro area countries. This year the trend continued mostly due to talk of interest rates going up in the UK. In previous months, Bank of England (BoE) Governor Carney has mentioned that an interest rate hike would happen by year end. However, the BoE’s outlook may have changed since economic data for the UK recently has not been so brilliant. Unemployment rate was last released at 5.6% slightly higher than its recent low of 5.5% reached during March and April. This has lead to the market beginning to doubt that an interest rate rise will happen so soon as previously thought. Any data related to triggering a rise inUK interest rates is important to consider when evaluating the strength of the GB pound.
Independently of this, Euro area 2015 balance of trade (which is the difference between exports and imports) has held at its highest levels for over 10 years (see chart below). June and August results beat expectations which has supported Euro strength.
However, last Thursday after an European Central Bank (ECB) council meeting, Mario Draghi (ECB President) said the maximum amount of sovereign debt held by the Central Bank would rise from 25% to 33%. Which means EU banks are allowed to sell more bonds and therefore achieve a higher level of liquidity (since bonds are a product sold to raise money in the form of debt). This increases money supply and may lead to a weaker currency.