Is The SNB Going To Unpeg The EUR/CHF?

 |  Includes: FXE, FXF
by: Elite E Services

The turmoil in Europe is heating up, and seems to be heading in a very extreme direction.

Recent articles on Bloomberg indicate SNBs pegging operations:

Investors are losing confidence in the single currency and seeking havens for their cash outside the euro area as Europe's debt crisis drags on in its third year. That has forced the Swiss National Bank to buy euros to prevent the franc from appreciating, and prompted the Danish central bank to charge for the use of its deposit facility while yields on U.K. two-year notes are less than 0.14%.

The article goes on to say:

The Swiss central bank's sales of the euro to rebalance its reserves are "reinforcing" pressure on the single currency, according to Kressin. Its purchases of top-rated European government bonds, particularly bunds, are also forcing down yields on those securities, he said.

The question is, how would the SNB handle a volatile situation in the event Finland, Greece, or Austria exit the euro? It could cause the euro itself to go up or down 5%, 10% or more in a short period of time. In either direction, the SNB would be forced to into the market to maintain the peg. And so the question is, how much are they willing to pay to maintain it? When is too much too much, so to speak?

This is mere speculation, there is no clear indication that the SNB will do this. However Forex traders need to consider the possibility. Switzerland is probably the country that influences Forex the most, next to the United States. The Bank of International Settlements, the central bank of central banks, is located in Switzerland. Swiss bank UBS (NYSE:UBS) is individually the second largest Forex player, second only to Deutsche Bank. And when the U.S. dollar collapsed to historic lows in 2011, it was the SNB that stepped in and effectively saved the U.S. dollar from complete collapse.

When the peg was initiated in 2011, the eurozone crisis was just beginning to unfold. But in one short year much has happened that fundamentally changes the fundamentals of the euro. The SNB needs to evaluate the new situation: For example if Italy did leave the euro, would the EUR/CHF peg stay in place? Would they include a peg to the Lira? There are many new variables that any careful central banker needs to consider. The SNB is notorious for doing this in secret, or should we say 'confidentially'. It is likely to assume that they are doing contingency planning for a possible euro collapse, as are most European governments and investors.

Is it also likely that one of these scenarios involves the unpegging of EUR/CHF? It is a near certainty that at least one scenario includes this reaction. However what is unclear is, what is the probability of that scenario being enacted?

Trade the unpeg with options

This trade is simple: Purchase two long options, a put and a call, with as far out expiry as possible (6 months), 50 pips above and below the current EUR/CHF price. Because of the peg, these options should be fairly cheap. If the unpeg occurs, EUR/CHF will jump in one direction, most likely down, but we won't know until circumstances present themselves. The option on the right side of the market should be deep in the money. If the unpeg does occur and the price moves quickly in one direction, the profit should be taken relatively soon after; what is common in situations like this is there will be a knee jerk reaction but then a reversal. So cash in the profit as soon as the price settles.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: The risk of loss in trading foreign exchange markets, also known as cash foreign currencies, or the FOREX markets, can be substantial.