Euro Hedging costs raise as traders reaction to Brexit

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Euro Hedging cost

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Investors in the euro are getting increasingly concerned about the risks surrounding the French presidential elections, pricing in the options market shows.

The premium needed to protect against swings in the single currency has now risen to the highest this year, while put options are the most expensive in relation to calls in almost two years. Specifically, investors seem most preoccupied with risks surrounding the second round of elections scheduled for May 7, with various gauges showing reduced anxiety before and after the event.

The increase in options pricing reflects concern that National Front candidate Marine Le Pen may prove opinion polls wrong — as happened with the outcome of the U.K.’s referendum on the European Union — to become president. While surveys so far haven’t shown her even close to a victory in May’s run-off, she is narrowing the gap with her rivals, contributing to this month’s more-than-2 percent drop in the euro.

Three-month implied volatility on the euro-dollar surged 172 basis points this month to as much as 11 percent Tuesday, the highest since Dec. 20. The premium on the two-month tenor, which captures the first round of elections on April 23, is almost 250 basis points lower than the three-month rate, suggesting that investors are seeking a hedge against the outcome surrounding the second round.

The difference between three-month implied and realized volatilities shows a similar concern, with the spread at 210 basis points Tuesday, the widest it has been since Dec. 19.

The spread between three-month and one-year volatilities is below zero, suggesting that investors aren’t concerned about risks engulfing the single currency beyond the French elections.

Risk reversals, a measure of the attractiveness of calls over puts, shows that investors are the most pessimistic on the euro-dollar in almost two years. Traders are paying a premium of 284 basis points to buy puts relative to calls, the most expensive since June 2015, when Greece held a referendum on its reforms.

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