That should alarm the central bank, given the failure of the Swiss franc to depreciate in recent weeks, even as the rise in risk appetite – that has heralded the start of 2012 – has weighed on other perceived haven currencies, such as the dollar and yen. The SNB introduced the floor in September after EURCHF hit a record low of SFr1.0094 at the end of August, as worries over the eurozone debt crisis encouraged rampant demand for the relative safety of the franc.
Morgan Stanley says although its position tracker shows positioning in the spot market is neutral, the pricing for longer-dated EURCHF options shows a market structurally biased for EURCHF downside.
The 25-delta risk-reversal skew, both vol-adjusted and outright, is close to zero for periods of up to one-month. That shows that investors view the raising or breaking of the SNB’s floor as equally likely in the short-term.
However, for maturities past six months, the skew becomes extremely exaggerated towards the downside.
| Risk-reversal skew in EURCHF |
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| Source: Morgan Stanley, Bloomberg |
Yilin Nie, strategist at Morgan Stanley, warns this does not mean that short EURCHF is a crowded trade.
Rather, he says, the exaggerated price for EURCHF downside protection indicates unusually high investor demand for, or interest in, longer-dated EURCHF puts. Indeed, the vol-adjusted three-month skew is at the 88th percentile when compared with the last five years.
“The implication is that any breach of the floor may trigger a wave of EURCHF selling,” says Nie.
He says, as barriers are hit, market makers would be automatically forced to delta-hedge the puts and barriers they have written by selling EURCHF, exacerbating the speed of the downside move.
“EURCHF could trade to all-time lows in the sell-off after a break in the SFr1.20 floor,” says Nie.