Thespis would be proud. Greece is now engulfed in a financial and political soap opera.
Who knows just where this will end up next?
Let's look at some options that the European Union has up their sleeves to deal with Greece and other rogue spend thrift states? We think there are only two realistic options:
1. Greece could be offered assistance based on strict conditions. This assistance might be in the form of a loan with guarantees from either the EU itself or from the International Monetary Fund. The IMF is not particularly favoured by EU members because it would mean that Greece would have to surrender fiscal authority to a U.S. dominated organisation. This would signal a failure of the EU which is not what the governing authorities in the EU want or would take too kindly to. Of course there is a massive proviso here, any loan or “assistance” is going to come at a price (cut spending), which to date, the Greek public seems unwilling to come to terms with or entertain.
2. The Greeks (willingly or otherwise) could float their own currency; bringing back to life the good old Drachma. Of course, with this they would be free to depreciate against the Euro. This will make the Greek economy more competitive (in the short run at least) and would accomplish a devaluation of the Greek government’s debt. Of course, it does not take a rocket scientist to figure that other nations might then follow suit rather than follow demanding conditions for any loan/bailout. This is the solution likely to be the most appealing to national politicians. In the short term at least (their political lifespan) it would likely avert the need to drastically cut spending and avert rioting in the street.
And the most likely outcome?
To our minds, it hinges upon the willingness of the all powerful unions in Greece to accept a dramatic reduction in their members’ standard of living. And upon the willingness of the Greek population to tighten their belts, by around 25%.
We don't think that option 2 will be the outcome.
And so, strange as it may seem, taking a long Euro position might not be such a silly idea.
The cost of deep out of the money calls are the cheapest they have been for quite awhile, relative to the cost of puts (risk reversals) as per the chart below.
Yes, business has never been better for writers of puts on the Euro, and boy are they pricing them like there is no tomorrow or the Euro (no pun intended).
click to enlarge
The behaviour in the option market is being mirrored by that in the futures market. Never has there been this level of short positions in the Euro.
We will refrain from saying that "anyone who could short the Euro has already done so" but it certainly feels like that right now. Just where is the marginal Euro bear going to come from?
It has been interesting to note that tour operators and hotels in Greece now prefer to get paid in USDs instead of toxic Euros. Oh yes, those contrary signs mount by the hour.
And the infamous words of John Templeton ring loud in our ears "invest at the point of maximum pessimism".
Given how cheap deep out of the money calls are on the Euro we think its a reasonable speculation to go long the Euro. It is fun to go against the crowd; especially when there is nothing more to lose than the premium you put in, and the reward/risk ratio is up there with holding deep OTM outs on the Nasdaq in March 2000, or maybe even being long CDS on Subprime mortgages (or whatever you might call them) at the start of 2007.
Disclosure: Long FXE via options