Saturday, January 4, 2014

Trade idea: exploiting the EURCHF peg

Last night, I was thinking about George Soros, the infamous man who "broke the Bank of England" and the reasons why the BOE lost against Soros. Long story short, the BOE pegged the British pound to the German Duetsche mark in the early 90s, even though the economies of both countries were heading in opposite directions at the time (UK was in recession while Germany was growing). The peg couldn't be maintained as investors and speculators shorted the absolute crap out of the British pound, and the BOE simply ran out of foreign reserves to buy and defend the British pound. 

Now what was special about this situation that allowed George Soros to bank over a billion dollars in profit? It was the peg. I realised that pegs can provide a near risk-free opportunity to make some profitable trades, depending on the nature of the peg. 

The Swiss central bank (SNB) has currently pegged the Swiss franc (CHF) to the euro, setting a floor price of 1.20000. This can be seen in the charts from 2012, when the SNB began supporting the CHF between April and August 2012.

The SNB's defence of 1.20000 provided opportunities to buy the EURCHF with near zero risk. If you bought at 1.20000 with a 10 pip stop loss at 1.19900, your stop loss would never get hit (as long as the peg existed). All you had to do was wait for the euro to eventually appreciate and bank your near risk-free profit.

Suppose we did take this trade, and bought EURCHF at 1.20000 with an ultra-tight 10 pip stop loss. The EURCHF peaked at  1.26500 in May 2013, 650 pips away from our purchase price of 1.20000. Our return would have been 65R. And remember this was with little risk, courtesy of the Swiss central bank. 

This isn't quite the same level as Soros, but the reward vs risk was still very asymmetric, in favour of reward. The main risk was the SNB de-pegging the CHF. If the EURCHF ever finds its way near 1.20000 again, keep an eye out for this opportunity. It's not often a central bank is on your side. 

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