Opinion

Felix Salmon

Chart of the day, Swiss franc edition

By Felix Salmon
August 22, 2011

EURCHF-vol-surface-082211.png

This chart comes from Eric Burroughs, who calls it “one of the best gauges for showing the extreme nervousness over what the endgame really is in Europe”. But I’m assuming here that you’re not the kind of person who looks at FX volatility surfaces on an everyday basis, so it might be worth a little bit of explanation.

The chart is showing how expensive it is to buy options on the EUR/CHF exchange rate — that is, the number of Swiss francs per euro. When the Swiss franc strengthens, as it has been doing of late, the exchange rate goes down. The current exchange rate can be seen in the middle the “Delta” axis, where it says “ATM” — that stands for “at the money”. So everything to the left of that line — the PUT contracts — shows the price of a bet that the Swiss franc is going to strengthen. And everything to the right of the line — the CALL contracts — shows the price of a bet that the Swiss franc is going to weaken.

Now the Swiss franc has appreciated a lot against the euro of late — you could get more than 1.5 Swiss francs to the euro this time two years ago, while a couple of weeks ago the exchange rate dropped to as low as 1.03, and it’s still at 1.12 right now. To put it another way, a 100 Swiss franc meal in Zurich would have cost you €65 two years ago, €76 one year ago, and €89 today. At this point, the Swiss franc is so strong that the Swiss National Bank is doing everything in its power to try to weaken it. So the time to bet on a strengthening Swiss franc was clearly in the past.

But just look at the chart — it’s much higher on the left-hand side, the PUT side, than it is on the right-hand side. That’s known as “skew”, and it means that the market is decidedly bearish on EUR/CHF. If you want to bet that the exchange rate is going to go back up, that will cost you quite a lot of money. But if you want to bet that the exchange rate is going to continue to decline, that’s going to cost you an absolute fortune.

And in fact the market seems to think that even if the Swiss National Bank manages to weaken the Swiss franc in the short term, over the long term its efforts won’t count for much. The lowest parts of the chart — the cheapest bets of all — are the ones saying that the Swiss franc is going to weaken over the long term of 18 months to 2 years. Meanwhile, the highest parts of the chart — the most expensive bets you can make — are the ones saying that the Swiss franc is going to strengthen a lot over the long term of 18 months to 2 years.

Some of this activity is hedging, of course, rather than speculation. Let’s say you’re one of those corporate chieftains attending Davos in January as a Strategic Partner. That’ll cost you 590,000 Swiss francs. In 2011, that was €457,000. But as of right now your Davos membership fee has already risen to €523,000; you might well want to lock it in right there before it goes any higher. (If you’re unfortunate enough to be paying in dollars, it’s even worse.)

But the main message of the chart is that people are almost irrationally worried right now. The Swiss franc is a classic flight-to-safety play, a bit like gold or Treasury bills. That’s why it has appreciated so much of late. But the markets are saying that its recent appreciation might only be the beginning, and that the Swiss franc might well end up being worth more than the euro pretty soon. Here’s how Burroughs puts it:

When the skew starts to normalize, then the market may be convinced that Europe is getting a handle on this crisis. We are far from that point.

I’ll trust Eric to keep an eye on this chart — I wouldn’t know where to start even trying to build such a thing. But it seems clear to me that he’s right: we’re going to wait a long time before this chart stops sloping down and to the right. Which is another way of saying that we’re going to continue to have a crisis in Europe for the foreseeable future.

Comments
3 comments so far | RSS Comments RSS

would be interesting to see the “vol surface” for USD/ gold… probably even more extreme skew

Posted by johnhhaskell | Report as abusive
 

The economy has the red hot, hot red, meltdown blues. Until there is a real, unified effort by both parties in the U.S. and by the EU to create jobs, nothing much is going to change. How could it?
Meanwhile, instead of everyone scurrying into bomb shelters as they did in the 1950s and 60s, all the money is being sucked into “safe havens.”
There is money to be made, even though now the faint of heart will fade away from the gold market. But, personally, I think there I still a LOT of room at the top.
Been using this to keep steady – I am recommending this small, stellar primarily technical analysis company: http://tinyurl.com/3wvd2mz
Be sure to try the free subscription. It actually is free and they don’t bug you. Nothing to lose. I’m just saying, Gary Wagner of the Gold Forecast is shockingly accurate. It is truly uncanny.

Posted by GrandestR | Report as abusive
 

Interesting to note that while the Swiss Franc is high against the Euro, the Euro is still at the upper levels of historical values against the US Dollar. You need $1.44 to buy €1.00 today, but back in the days of the post launch “market test” of the Euro’s strength IIRC one Euro could only buy $0.87.

In global terms, aren’t they the only ones that really matter since they are the two world currencies fighting it out to be the World’s main Reserve Currency?

Posted by FifthDecade | Report as abusive
 

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