The Swiss National Bank plays the FX options market

By Felix Salmon
September 8, 2011
Eric Burroughs has a fabulous scoop today: the Swiss National Bank isn't just buying euros at a rate of 1.20 Swiss francs to the euro.

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Eric Burroughs has a fabulous scoop today: the Swiss National Bank isn’t just buying euros at a rate of 1.20 Swiss francs to the euro. (If that was all it was doing, in fact, it would yet to have spent any money at all: the exchange rate hasn’t hit that level since the announcement.) Instead, or as well, the SNB is intervening aggressively in the FX options market. And not the plain-vanilla exchange-traded options market, either: the SNB seems to have been a huge seller of forward volatility agreements — essentially taking a massive short position in the volatility of the euro/Swissie exchange rate.

But a picture, here, tells a thousand words. If you recall my post from immediately after the SNB announcement, you’ll remember these charts:


The left-hand chart is the euro/Swissie volatility surface on August 22; the right-hand chart is the same surface on September 6, after the announcement. It’s even more skewed: people are still bearish on the euro and bullish on the Swiss franc, and expecting lots of volatility ahead.

Now check out what the same surface looks like today:

EURCHF vol surface 090711.PNG

Now that’s what I call a dramatic one-day move. And remember, this move came after the market reacted to the SNB announcement — no one was expecting this, not even after the SNB said what it was going to do.

This is a bold move by the SNB, even if it might prove expensive should things not go according to plan:

Selling volatility also means that the SNB has forced the euro/Swiss franc options market to turn suddenly long gamma, so that the hedging of option dealers would help dampen the daily moves in the currency pair. The opposite happens when the options market is short gamma, exacerbating sharp market swings.

“Long gamma”, here, means that if you hold an option, it will make a lot of money even on a relatively small move in the currency pair. By contrast, before this intervention, implied volatilities were so high that the Swiss franc needed to move as much as 4% in one week in order to make options trades profitable. (Which, of course, it did.)

Essentially, the SNB is trying to calm down the options market, and thereby calm down volatility in the swap price: the two feed off each other very closely. But the problem with doing things like buying double-no-touch options is that it gives the market every incentive to try and make the exchange rate hit the strike price — it’s almost an “I dare you”. So far, the market hasn’t really tested the SNB’s steadfastness on this issue. But the two are sure to butt heads at some point. And the SNB here, is maximizing the amount it has to lose if the market wins.


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I get the feeling here that the Swiss know what they’re doing. Just a gut feeling, nothing more.

Posted by jesse1 | Report as abusive

I would think the SNB’s options purchases are a way of signaling credible commitment to their policy. Perhaps you can explain why you think otherwise (if you do)?

Posted by ginsbu | Report as abusive

“And the SNB here, is maximizing the amount it has to lose if the market wins.”

Yes, but there’s virtually no way the market will “win” in the short term. Putting aside the fundamental overvaluation of the CHF, if you still believe the market “wants” it to strengthen against the EUR, the SNB can and will step in to keep it above 1.20. They surely have enough firepower in the short run to enforce whatever exchange rate they want and thus profit on their options positions. That’s true even if you think longer term they’ll have to abandon their intervention.

Posted by loudnotes | Report as abusive

Option Traders: “We think the Swiss Franc should rise in value relative to the Euro a bunch more. We bet lots of Euros that this is what will happen. Suffer, Swiss Central Bank!”

Swiss Central Bank: “I just committed to a 4% per year inflation target for the next four years, and digitally credited a bunch of brand new Swiss Francs to the Swiss Treasury’s account, to ensure my inflation target is met. Since higher inflation is now assured, the value of the Swiss Franc will be falling, not rising. But thanks for playing!” *takes option traders’ lunch money*

Posted by Auros | Report as abusive

“the Swiss National Bank isn’t just buying euros at a rate of 1.20 Swiss francs to the euro. (If that was all it was doing, in fact, it would yet to have spent any money at all: the exchange rate hasn’t hit that level since the announcement.”

Err, are you sure about that? Before the announcement the CHF was heading for parity with the Euro and had reached 1.04 at one point; now it’s trading at 1.21 so at some point it passed exactly through 1.20. The Swiss Government don’t mind if there’s a move up towards 1.30 though as that will bring weakness without too much inflation. And since there’s an election campaign in progress for the Swiss Parliament at the moment, all bets are off for how long this will continue.

Posted by FifthDecade | Report as abusive

The game will not end well for the common citizens of Switzerland. The SNB is waging a war it cannot win. It may claim victory in a couple of battles but in a few months time I’m quite sure the algo guy’s will develop traps to knock the CB down.

Posted by rucca | Report as abusive

Rucca, you’re not paying attention to what the Swiss are doing.
Their central bank is basically saying, “We’re going to print enough money to buy up everything you want to do to our currency, until you stop buying our currency and making us uncompetitive on the world stage.”
i.e. they are guaranteeing a loss to people trying to buy up Swiss francs.
If the franc falls as a result, that makes Swiss exports cheaper, and helps the country out, as exports are what keeps the Swiss in business, much like Germany.
With the options game, they are basically looking at the speculators trying to leverage funds too, pointing a finger and saying “we haven’t forgotten you people exist, either.”

Whether they actually have the stomach to print all that additional money is something else.

Posted by REDruin | Report as abusive

Swiss FX reserves exploded to 253bn (50% of GDP) by end of August (from 112bn end of 2010) – that’s before the “peg”. How much until they throw in the towel? 100% of GDP? 200%? That would be another 750bn Swissies or 625bn EUR. Leverage of 100x is not unheard of for FX speculators. So 6.25bn in equity would be enough to break the SNB. Swiss Franc is such a tiny currency (0.1% of world currency reserves), while Euro is a Goliath (27.3%). So “David” wants to take on a giant 273x larger. Good luck. Did you see the ECB statement after the announcement on Sept 6? Go and read it. Because it basically says, in unusually frank words, “The SNB acted on its own, it’s their responsibility, and don’t count on us to help if this goes wrong”. Zero support from your “sister” central bank?!
And what is the SNB buying – a currency in the process of dissolving. Thanks to their move, you can get it 10% cheaper now. What a bargain.
As to the fiddling of the SNB with option prices – that’s fantastic.
Example: October 125 FXF (Swiss Franc ETF; I know it’s not EUR/CHF, but this is just for illustration) calls initially cost $0.35 at 19% vola (underlying 114.20). Should the peg fall, FXF could jump to 125, and the call would be worth $3.30 for a profit of 842%.
But if you manage to buy the same call with 12% vola, it would cost you only $0.02, rising to $2.08 at 125, for 10300% profit (the market marker will probably ask $0.05 for it as far-otm* options are more expensive than atm*).
So PLEASE SNB, bring down the vola. Make my day, week, month, year…

Posted by Gloeschi | Report as abusive

After reading the piece by Eric Burroughs it dawned what the SNB might be doing here. Their thinking is: “We will keep the Euro/CHF above 1.20, so it can’t go below, so we can make free money by selling naked puts on the Euro/CHF – yippee!”
A large option seller, of course, depresses vols. And if the “peg” holds for a while, vols will come down anyway (EUR/CHF was, until 2010, a low-vol cross).
But wait until the peg gets attacked. Unfortunately for the Swiss tax payer, the SNB’s losses might be amplified by their questionable option trades.

Posted by Gloeschi | Report as abusive


Big FX traders dont’ use 100:1 leverage.

Also, the SNB is bascially saying “I dare you” to the FX market. It can sustain losses forever as far as we know, and they don’t have to mark to market. So what if it loses $100 euro over the next month? It just sells more – maybe 2X GDP more until it’s a winner.

Central banks can’t go broke. They are the ones who print the money. This has always been true, but now it’s widely recognized as true.

This is what Felix doesn’t understand about this trade. The world changed in the last 12 months.

Posted by MrE23 | Report as abusive

It’s a win-win situation for the Swiss Franc; if they buy Euros with Swiss Francs, the CHF goes down. If they spend so much doing this that the debt goes up, the CHF goes down. If they weaken the economy through their actions, the CHF goes down.

Whatever happens, the Swiss Franc goes down – and that’s their only goal.

Posted by FifthDecade | Report as abusive

The Swiss know what they are doing and CHF will get weaker. It also seems that the US$ strengthens against the Euro. Which currency will take over? NKO ? Seems all confusing except that the Euro will be battered until Greece leaves the Eurozone. Any comments?

Posted by Rabbit11 | Report as abusive