As global risk once again trends higher, German volatility is especially elevated. For investors who think short-term fear is overblown, they can consider using a short straddle on the iShares MSCI Germany ETF.
A short straddle is an options strategy where an investor takes no view of the up or down direction of shares on inception. Instead, the trader believes shares will move less either way than the market is anticipating.
With EWG ETF trading around 22 a share Friday, investors can consider placing a short straddle by selling the 22 call and 22 put on the Oct. 21 expiry. This trade can be placed for a credit of $2 per share, which also coincides with the maximum gain of $200 if the shares trade at 22 on expiration.
An investor will earn a profit if EWG is trading between 20-24 on expiration.
German Volatility Elevated Compared To Historical Level
The EWG Oct. 21 options are currently trading with an implied volatility of 31%. This is elevated because historical volatility is 23% and 29% for the past 30 and 200 days, respectively. For the same period, the S&P 500 is implying volatility of 21% while realizing 17% over the last 30 days. This implies that German volatility could be expensive relative to U.S. volatility.
There are numerous risks that could justify this higher German volatility.
Foremost is Europe's precarious energy situation heading into winter. Electricity prices have soared and supplies remain limited. Any news on energy supply, as well as the effects of higher prices on growth, will drive volatility. Nevertheless, October's options will not have any risk of inclement winter weather, which is unpredictable and could cause major volatility.
Rate concerns and inflation also remain elevated globally. The European Central Bank will meet next week. After a record inflation print on Wednesday, there is now an 85% chance of a 75-basis point "jumbo" interest-rate hike in the eurozone.
This is far more certain than the 50-50 chance of a 75-basis point hike that analysts saw before the inflation print on Wednesday. And it should provide a bit more certainty for the European market. Nevertheless, rhetoric on future rate increases will also be a big source of volatility and will be closely watched.
It is important to note that even considering these risks, Germany has had a tumultuous year thus far. If investors expect a similar level of volatility to continue, a short straddle on EWG ETF is an attractive trade.
The iShares MSCI Germany ETF is down 35% year to date and is trading below well below its 200-day moving average amid a long downtrend.
