New Trade $EWG: Knocked Worst

by Dan March 6, 2014 3:08 pm • Commentary

Last Thursday in this space I described my amazement that risk assets did not appear to be pricing in a whole heck of a lot of concern relating to the heightening tension in Ukraine (read below) .  While Monday’s sell off in global markets finally reflected some concern it was mostly concentrated in Russian equities and some of Russia’s closet trading partners.  As the situation continues to intensify, most major markets have recovered Monday’s losses and them some.  For those who think that the equity strength since Monday’s close in New York, and the subsequent new highs in the S&P 500 have signaled the all clear,  you may want to take a closer look at the headlines.  From where I sit the ante seems to have been upped by the Russians and few risk assets seem to care.

There are clearly some cross currents. While equity strength and bond weakness speak to general calm, the fact that the VIX remains above 14 (and not back to the prior lows) and Gold is up 1%, seemingly getting ready to make new 4 month highs, suggests that some investors are paying attention.

The macro stuff is a bit hard to pin down so I prefer to focus on which country might be the most impacted by continued Russian aggression. Germany.

Germany is one of Russia’s largest trading partners.  The New York Times laid out many of the details of that trade relationship in a Monday article, with the following graphic:

Screen Shot 2014-03-06 at 2.08.41 PM

The DAX, Germany’s main stock market index, was down 3.5% on Monday after the weekend news of Russian aggression.  That was one of the worst performances in developed markets that day.

The technical situation for the DAX also looks precarious, particularly if further aggression leads to a deterioration in diplomatic efforts:

DAX index daily, 50 day ma in pink, 100 day ma in green, 200 day ma in yellow, Courtesy of Bloomberg
DAX index daily, 50 day ma in pink, 100 day ma in green, 200 day ma in yellow, Courtesy of Bloomberg

The index has held above the rising 200 day ma throughout the past year.  However, the DAX has bounced much less this week than other markets (like the S&P 500), and has made a lower high vs. its January high.  It also sits right on its 50 day ma around 9550, which is the unchanged mark on the year.

To express a view in the DAX I want to look at the EWG, the iShares MSCI Germany etf that tracks German equities. In particular, I want to look at options on the EWG because they are not being priced as if there is the potential of a significant geopolitical event. Vol is low despite the German DAX’s 3% decline on Monday on the slightest hint of Russian boots on the ground in Crimea.

The 2 year chart below of the 30 day at the money implied volatility (blue line) of the EWG shows it picking up off of the lows, but still 50% below where it was a in the summer of 2012.  I would point out one other thing on the chart. The white line that is the realized volatility of the EWG shows how much the etf has actually been moving, and it has started to pick up. If this continues, the relative cheapness of EWG options will be a thing of the past.

EWG 2yr chart of 30 day at the money implied vol (blue) vs realized vol (white) from Bloomberg
EWG 2yr chart of 30 day at the money implied vol (blue) vs realized vol (white) from Bloomberg

EWG puts or put spreads could be used as fairly cheap protection against a portfolio of US stocks or for an outright bearish bet.  I have no idea whether things will heat up in the Ukraine or not, but it would be lazy not to look for ways to protect gains or look for trades that are contrary to the current markets’ complacency.

Trade: EWG ($31.50) Bought the July 31/27 put spread for 1.00

– Bought July 31 put for 1.35

– Sold July 27 put at .35

Break-evens on July Expiration:

Profits: between 30 and 27 make up to 3.00, max gain of 3.00 at 27 or lower.

Losses:  between 30 and 31 lose up to 1.00.  max loss of 1.00 above 31


This structure uses the recent bounce in global markets and the corresponding fall in implied volatility to position a bearish/defensive position in the developed world’s most at risk index. July not only gives us alot of time but also will be very effected if implied volatility spikes on news out of the region.



Original Post February 27, 2014: Name That Trade – Putin’s Game of Chicken Kiev

In case you missed it, things continue to heat up in the Ukraine.  Here is the headlines we woke up to this morning from the


With the last couple weeks’ violence in the Ukraine we’ve seen a revolution in the capital of Kiev that caused the Russian backed President Yanukovych to cut and run. I am hard pressed to think that the stepped up rhetoric overnight does not result in further armed confrontation.  With the Olympics over and 98% of the global media out of the area, Russian President Vladimir Putin can now flex his muscles.

David Clark of the Russia Foundation had a guest post in the FT this morning outlining what he feels are Putin’s options.  Great read (here) in full, but here are some excerpts:

The one thing we can be certain of is that he isn’t about to give up on Ukraine. It remains Russia’s biggest gas export market, a crucial transit route to the rest of Europe, the main base of Russia’s Black Sea Fleet and home to an estimated 7.5m ethnic Russians, including an unknown number of Russian passports holders.

Putin’s short-term options for recovering lost ground in Ukraine are not good. Despite the decision to raise the alert status of Russian troops based near the border with Ukraine, a military intervention to partition the country would leave Russia dangerously isolated. Under the terms of the 1994 Budapest Memorandum, signed as a condition of Ukraine’s decision to relinquish its stockpile of Soviet-era nuclear weapons, Russia, along with the US, France and the UK, has pledged to uphold Ukraine’s territorial integrity. Any violation of that undertaking would put it on a collision course with the West.

The ideal solution would be for the EU, Ukraine and Russia to work together to create a common economic space from which everyone would benefit. Unfortunately, all the indications are that Russia remains a long way from being willing to embrace the kind of change that would make this possible. Ukraine is likely to remain an arena of tension and competition for some time to come.

So, what’s the trade?

My sense is that for some odd reason, risk assets are not pricing the potential for a showdown in the Ukraine. And this is at a time when U.S. / Russian relations are as bad as they have been in many years. The question is, what are the ramifications of armed conflict?

First, the Ukraine defaults  and aid could be hard to come by as Russia is not going to pump billions into Kiev while the West is supporting the Revolutionaries.  U.S. Treasuries are probably the best trade from the long side.  Despite the relative cheapness of Russian equities, they probably finally make a new low after hovering above 5 yr support (5yr chart of RSX, the Market Vectors Russia etf):

RSX 5yr chart from Bloomberg
RSX 5yr chart from Bloomberg

And then what are the reverberations for other emerging market currencies if and when Ukraine defaults on its debt??

Do we see a spill over into other emerging markets like Turkey that have been battered now for months and do we see a re-ignition of the emerging market fears that caused the volatility in global markets in January into early February? Is it time to re-short EEM using a $40 stop on the upside?

Or maybe the better risk/reward trade is to simply play for increased volatility with a cheap VIX structure like the one CC and Enis laid out last week.  The Russian Ruble is right at its all-time low vs. the dollar, hit exactly 5 years ago, on February 27th, 2009.  That was a much different risk environment across the world.  Today, Russian stock traders are back in crisis mode, while U.S. traders party like it’s 1999.