ECB Meeting – Your Volatility Trading Playbook

Granted, we get EU manufacturing and services PMI (on Wednesday), but it’s Thursday that traders need to be aware of the event risk, and how it could impact their portfolios.

So, on Thursday (at 18:00aest) we get the German IFO survey, and on any other day, I’d expect this to get some attention from the market. That said, with the ECB meeting shortly after (at 21:45aest), unless the survey is an absolute calamity, I wouldn’t expect the IFO survey to be a market mover.

EUR futures positions – the market is net short 31k contracts

Source: Bloomberg 

Trading the ECB meeting

The first consideration with the ECB meeting is whether they lower rates at this meeting. The market ascribes a 33% probability the bank ease by 10bp, taking the deposit rate to -50bp. So, in theory, there is a small risk the market is disappointed when they likely leave rates unchanged, but that factor will be short lived as traders turn to the outlook on policy.

Consider that 34 of 39 economists (polled by Bloomberg -see below) see rates being left on hold, so if the ECB wants to cause a reaction, they know they know the hurdle to do so is low. One research house (Commerzbank) is even calling for a 20bp cut, which, should it play out would send the EUR into 1.1100 given how surprised the market would be.

Source: Bloomberg 

As said though, a cut at this meeting seems unlikely, and it’s the guidance on what comes in the months ahead that the market will really key off.

The most likely path is that the deposit rate remains at -40bp, where it’s the tone and level of concern that traders will look to buy or sell EURs. It is widely expected that the ECB alter its forward guidance on any future rate-setting, moving to a full easing bias, which would validate the consensus view that the ECB ease rates in the September meeting. More explicit guidance on re-starting its asset purchase program (QE) in the months ahead would also keep EUR bears fairly content.

How options markets can give us a statistical edge when trading event risk

EURUSD implied volatility for options expiring on Thursday sits at 7.2%. We can use this implied volatility and apply to the Black-Scholes formula to understand the implied move (up or down) set by the market through this time. So, applying this logic, the market implies a move in EURUSD of 47-pips (high or lower) through Thursday and into the NY options expiry.

As you can see from the chart (the white shaded area), the market believes moves in price will be contained to a range of 1.1152 to 1.1246, with a 68.2% level of confidence (one standard deviation).

If the market is really surprised by what they hear, we could see EURUSD trading into, but no further than 1.1127, which using options pricing is a move (from the current spot price) the market feels 90% confident it won’t breach. For those running mean reversion strategies on the day, the 1.1120/40 area is where I would be looking to buy.

On the upside, if the market is disappointed by what they hear, then traders feel EURUSD should not overshoot 1.1252 (with a 68.2% degree of confidence). However, if we take the confidence factor out to 90%, EURUSD should not trade any higher than 1.1285. This is interesting as it marries nicely with the July highs. If I had no position in EURUSD and was looking at high conviction levels to sell into on the day then 1.1270/85 would be where I would be looking as a short-term trade.

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Chris Weston, Head of Research at Pepperstone.

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