Pairs Trading Strategy: Long PLN/USD - Short PLN/EUR

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Includes: DRR, ERO, EUFX, EUO, FORX, FXE, UDN, UDNT, ULE, URR, USDU, UUP, UUPT
by: Discount Fountain

Summary

While the zloty and euro traditionally move together, the two have seen divergence in recent months.

I expect the U.S. dollar to depreciate against the euro given concerns regarding timing of interest rate rises, as well as higher oil prices.

In this regard, a long PLN/USD versus short PLN/EUR position could prove to be a good arbitrage strategy.

In a recent article, I argued that in spite of a recent appreciation in the Polish zloty versus the euro, I expect that the two currencies will move in tandem given an economic recovery in both countries. Strong trade links between Poland and the Eurozone would mean a strong likelihood of currency convergence in spite of interest rate differentials.

However, given that the zloty did deviate significantly from the euro for a time - and concurrently depreciated significantly against the U.S. dollar while appreciating against the euro - an arbitrage opportunity may exist between the PLN/EUR and PLN/USD currency pairs.

Since the beginning of 2015, the zloty strengthened significantly against the euro from a level of 0.2325 to 0.25. Conversely, the zloty has also been weakening significantly against the euro from the beginning of 2014, from a level of 0.3250 to 0.2750. However, in analyzing the two currency pairs on a five-year basis, the two pairs adhere to the statistical property of cointegration, i.e. while the two currency pairs may diverge over the short term, they ultimately converge over the long term. Additionally, for every 1% rise in the PLN/EUR, the PLN/USD is shown to rise by 1.28% based on five-year data. In this regard, should the zloty rise against the euro - it is likely to appreciate by an even greater magnitude against the U.S. dollar.

In this regard, a potentially viable arbitrage strategy would be taking a short position on PLN/EUR and a long position on PLN/USD. As it stands, I expect that the euro will see appreciation in the coming months as concerns over rate rises (or the lack of them) in the United States coupled with higher oil prices will place downward pressure on the U.S. dollar. I expect that any positive economic news from the Eurozone will likely be reflected in the zloty given the strong trade links between these two economies. However, given that the PLN/USD appears to demonstrate more upside on a statistical basis, taking a long position on this currency could maximise upside while limiting downside risk on a short PLN/EUR position.

In short, I expect the zloty to appreciate in tandem with the euro going forward. However, a short PLN/EUR position guards against any potential appreciation in the euro against the zloty, while a long position on PLN/USD maximizes upside from a depreciating U.S. dollar.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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