Meet the new boss, Same as the old boss – FEZ

by Dan July 14, 2016 2:57 pm • Commentary• Trade Ideas

We’ll be fighting in the streets
With our children at our feet
And the morals that they worship will be gone
And the men who spurred us on
Sit in judgement of all wrong
They decide and the shotgun sings the song


The change, it had to come
We knew it all along
We were liberated from the fold, that’s all
And the world looks just the same
And history ain’t changed
‘Cause the banners, they are flown in the next war

Won’t Get Fooled Again
The Who

Wow, in hindsight, this could have been the theme song for the Leave vote in the UK’s late June Brexit vote.  But I’ll remind you how the song ends—> Meet the new boss, Same as the old boss.

So let’s revisit Europe a few weeks on.

On the eve of the UK’s Brexit vote I detailed a bearish view on European equities (European Vacation), having nothing to do with my incorrect belief that the Brits would vote to remain in the EU, and Euro stocks would rally.  I expressed the view in the Euro Stoxx 50 etf, the FEZ. This was a great example of massively overthinking things, and constructing a way to complicated trade that wasn’t right for the swift Brexit gap lower (Penny Wise Pound Foolish).  In a nutshell my bearish near term view for European stocks on June 23rd was:

it seems like most financial market volatility would take place prior as opposed to after the resolution.  It’s also been my view that the the bigger issue facing Europe is the ECB’s push into negative interest rates. That effort to stimulate growth has created a unique and uncertain environment for risk assets. Any demonstrable lack of effectiveness of NIRP to achieve its goal will cause downward volatility spikes in the back half of the year, Brexit or not.

Well SX5E has filled in most of the Brexit gap, but remains in a downtrend, and it’s my view view that the disorderly panic in the immediate aftermath of the vote, has been followed by a curious buy panic despite no fundamental improvement aside from the hope of more stimulus. Let’s be clear here, more stimulus means lower rates and that has not been good for equities in the EuroZone. If the speculation is that the vote will lead to fiscal stimulus in the region (which would positively affect risk assets) I’ll remind you that this stimulus can only be funded with more debt. The recovery in Europe has not gotten better since the Brexit vote, and things remain uncertain.

As my friend and co-panelist on Options Action, Carter Worth of CornerStone Macro Research likes to say, “draw the lines any way you want”, but this is how I drew them on June 23rd, and this is how I draw them now on the SX5E, and both point to the same conclusion, despite me getting a lot wrong in between:

[caption id="attachment_65007" align="aligncenter" width="600"]SX5E 2yr chart from Bloomberg SX5E 2yr chart from Bloomberg[/caption]

To my eye this sets up as a nice short entry in the FEZ at $32 with an eye towards a break of support at $30:

[caption id="attachment_65008" align="aligncenter" width="600"]FEZ 4yr chart from Bloomberg FEZ 4yr chart from Bloomberg[/caption]

Short dated options prices have come down considerably in the last few weeks, but note that options volumes can be thin in this etf, despite total open interest of 157,000 options:

[caption id="attachment_65009" align="aligncenter" width="600"]FEZ 1yr chart of 30 day at the money implied volatility from Bloomberg FEZ 1yr chart of 30 day at the money implied volatility from Bloomberg[/caption]

If you agree that nothing has changed for the better in the last month in Europe, and that new stimulus might be face with the same challenges of old stimulus, then a short entry after the recent bounce in Euro stocks makes sense.

So what’s the trade?

Right now FEZ is back to its 50 day moving average. A failure here would not be great but without any news it may be a minor pullback and a period of consolidation. The next major move will come from how Brexit negotiations and ECB policy play out over the next few months. Theresa May, the new British PM seems ready for the fight with the EU as CNN said today, “May Builds Brexit Army“. As far as the EU is concerned, simple game theory says they should be ready to punish Britain to discourage others from threatening exits. Make no mistake. This story has many plot twists to come.

*Trade: FEZ ($32.05) Buy Nov 32 / 26 put spread for 1.50

-Buy to open 1 Nov 32 put for 1.75

-Sell to open 1 Nov 26 put at 25 cents

Break-Even on Nov Expiration:

Profits: between 30.50 and 26 of up to 4.50, with max gain of 4.50 at 26 or lower.

Losses: up to 1.50 between 30.50 and 32 with max loss of 1.50 above 32

Rationale: This position breaks-even at level the etf was trading at 5 trading days ago, and just above an important long term technical support level.