June 13, 2011 / 3:58 PM / 9 years ago

Analysis - Swiss franc option structures point to more gains

LONDON (Reuters) - The Swiss franc is likely to strengthen further against the euro as investors seek safety from the euro zone debt crisis, increasing demand for options protection against greater gains.

An employee handles 100 Swiss Franc notes in the treatment centre of the Canton of Vaud Bank near Lausanne February 17, 2011. REUTERS/Denis Balibouse

The franc, up 9 percent against the euro since early April, hit a record high near 1.2000 per euro on Monday. Traders say there are substantial options barriers around that level, a break of which would accelerate gains.

If the franc goes much higher, investor concern about whether it is overbought will increase, potentially driving some into, for example, the Swedish and Norwegian crowns. They, like the franc, are backed by sound economies.

“All the forces that have been driving euro/Swiss franc lower remain in place. Until the market is comfortable with the idea that Europe is containing the second phase of the debt crisis, euro/Swiss will probably be a sell on rallies,” said Audrey Childe-Freeman, strategist at JP Morgan Private Bank.

Franc gains have been exacerbated as investors have sought to limit exposure to the euro just as concerns about fiscal stress and weak economies have dented the appeal of more liquid alternatives - the U.S. dollar, Japanese yen and sterling.

The euro’s losses have led to strong demand from companies for protection in downside euro/Swiss franc options — bets on franc strength.

As options with strikes close to spot levels (at the money) have become more expensive, demand is rising for long-dated options with strikes well below spot (out of the money), in this case around 1.15 francs.

“Whoever sells these options has to hedge, and as part of the hedge they sell euro/Swiss franc in the spot market, so that can push euro/Swiss lower,” said Michael Sneyd, currency strategist at Societe Generale.

The jump in demand for downside euro/Swiss franc options is reflected in risk reversals, which measure the relative demand to buy euro/Swiss franc puts — bets on a currency falling — over calls — or bets on it rising.

One-month euro/Swiss franc 25-delta risk reversals are trading around 1.8 percent in favour of Swiss franc calls, having hit a six-month high of 1.9 percent at the end of May, a sharp rise from around 1.1 in early May.

“If euro/Swiss franc continues to track lower ... then you’ll see the risk reversals move with it. Puts will become more expensive and corporates will have to put on options further out of the money,” SocGen’s Sneyd said.


Analysts and traders cited talk that a large number of five- and 10-year euro/Swiss franc option structures with downside strikes at 1.20 francs were sold before the 2008 financial crisis.

Holders of these long-dated options have reportedly been seeking to hedge existing structures via options with strikes much lower than 1.20.

“As spot is moving lower so more and more of these strikes are moving from out-of- to in-the-money. This is acting as a snowball, a factor which is just self-feeding,” said Carl Hammer, strategist at SEB in Stockholm.

Before the 2008 crisis the franc — which was trading at around 1.60 per euro — was often used to fund carry trades, when money is borrowed in low-yielding currencies to invest in higher-yielding assets.


Some analysts say franc strength may be justified by solid economic fundamentals, strong productivity, relatively low inflation, and trade and current account surpluses.

“With Switzerland having such large external surpluses and growth picking up it does not look like the Swiss franc is gravely overvalued,” SEB’s Hammer said.

Sneyd said SocGen’s short-term valuation model, which incorporates euro zone fiscal concerns, shows 1.20 francs per euro is “quite easily obtainable,” though much beyond that it starts to look overstretched.

“If we saw another 5 percent appreciation, that might be too much of an overshoot and you might see some switching out of Swiss francs into Swedish and Norwegian crowns.”

He added both Sweden and Switzerland were good proxies for Germany as producers of high-end exports.

Technically, analysts can only estimate projected support levels for the euro/Swiss franc because it is trading at record lows, but these range between around 1.15 and 1.18 francs.

“Momentum turned decidedly bearish late April. The euro is not at all oversold, therefore we continue to expect further declines where 1.20 and 1.16 francs are measured targets,” said Nicole Elliott, technical analyst at Mizuho.

Additional reporting by IFR commentator Richard Pace

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