Murad Sezer/Reuters
Turkish President Tayyip Erdogan
- Options-market activity suggests traders aren't yet worried about Turkey's currency crisis spreading to other countries.
- Credit Suisse derivatives strategists said a bullish reversal could be coming, having observed that a key emerging-market exchange-traded fund is trading differently compared to other crises.
- They offered two options-market trades that would profit from this reversal.
Wall Street is betting that Turkey's currency crisis will not spread to other countries, unlike the Latin American situation in 1994.
As the Turkish lira plunged to record lows against the dollar last week, other emerging-market assets also tanked on fears of so-called contagion.
But on closer look, traders are betting that those fears won't come true for now.
"We think the markets have got it right that there is limited risk of contagion from Turkey," Mandy Xu, the chief equity derivatives strategist for Credit Suisse, said in a note on Tuesday.
Xu is specifically looking at the iShares MSCI Emerging Markets exchange-traded fund (EEM), which has slumped 4% in the past week. She observed that its implied volatility, which reflects traders' expectations for big swings in either direction, has not moved as much as the ETF's price.
Implied volatility is also muted relative to previous times when EEM sold off, Xu said. The implied volatility for one-month at-the-money options was near 18.5% on Tuesday; it spiked as high as 40% during the Chinese yuan devaluation scare of 2015. "In fact, 18.5% is right around the 5Y average for EEM vol, so the options market is pricing in Turkey to be just a typical EM catalyst, not indicating wider contagion," Xu said.
Additionally, the different stock markets that make up EEM aren't moving with a weaker uniformity than was seen during previous emerging-market crises, Xu said.
Credit Suisse
The emerging-market sell-off pushed Credit Suisse's Global Risk Appetite Index into "panic" territory.
"What's interesting is that this time around, we're entering 'panic' despite strong growth (historically risk appetite panics have coincided with periods of weak IP momentum)," Xu said. "Our econ team finds that risk appetite 'panics' have historically offered good entry points for reversal trades."
Here are Credit Suisse's top trade ideas for a bullish reversal in the coming weeks :
- SPY call spread collar: with the recent uptick in vol and steepening in skew, we like selling the SPY Oct'18 265 put to buy the 287/294 call spread for $0.06 (spot ref 283.13). The put is more than 6% below current levels while you make $7 if S&P rallies 4% in the next two months. We like the asymmetry in the risk reward profile for this trade. ***The risk to selling a put is significant. The risk to buying a call spread is limited to the premium paid.
- EEM call spread: given the flattening in skew in EEM, call spreads set up well for those who want to play a rebound with spot hovering around the 1-year low. We like the EEM Oct'18 44/46 call spread for $0.50 (ref 42.66) giving you max 4x leverage to position for 3-8% rebound in the next two months. ***The risk to the trade is limited to the premium paid.
Tuesday's trading indicated that some calm was returning to Turkey's markets. The lira stabilized after more than a week of losses that pushed it above 7 per dollar, gaining 5% to trade at 6.5238 against the dollar at 11:23 a.m. ET.
It was dragged lower by concerns surrounding Turkey's dollar-debt burden, US economic sanctions, and President Recep Tayyip Erdogan's interference with how the central bank is fighting 16% inflation.
The Turkish lira has slumped 71.5% this year.