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With a key European Union summit looming, the euro may not have priced in a truly dramatic outcome.
Got tail risk?
Not enough, at least when it comes to the euro, says Steven Englander, global head of G10 FX strategy at Citigroup.
Englander has looked at pricing in the option market to gauge how likely investors consider an extreme move in the euro in the next six months - in other words, tail risk. In his opinion, "investors are gravitating to a view that the sovereign crisis will play out in debt markets more than in currency markets." And that's now how Englander sees it: "to us, this looks to be an extremely hopeful view of how events will play out."
To gauge investors' view of euro risk, Englander examined the premium demanded for options that would pay off in the event of a 15 percent drop in the euro. The premiums are lower than they were last fall, which means investors aren't buying as much protection as they were before Spain and Greece reached their current crisis states. Option premiums are also modest in the other direction.
"For a crisis that dominates asset market moves and discussion, the actual risk that is priced into the tail seems remarkably low," Englander wrote in a note to clients.
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