Arcángel de Jesús Montoya
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Arcángel de Jesús Montoya in Money Trafficking,

Buy French Volatility Now

In the wake of the recent terrorist attacks in Nice, France, it is time to start thinking about the upcoming volatility in the French stock market and ways to exploit it. About two weeks ago, the airport in Istanbul, Turkey, was also assaulted by ISIS's terrorists. The market did not react immediately but eventually made a nice upward move, making my suggested option strategy profitable. You can read about it here. I am thinking about doing the same trade now with options on the French stock market by buying August options on iShares MSCI France Index (ETF). Here is the trade in details:


The premium on the options is quite expensive, to be honest: the straddles is worth around 12% of the current market price of the ETF's unit (this translates into an annualized volatility of about 42%). Nevertheless, I think the options are still undervalued because the streak of terrorist attacks in Europe seems to be non-stopping, and the French index has shown negative dynamics since the November 2015 Paris attacks:

(Source: Google Finance)

As you can see in the graph above, the ETF lost around 12% of its value in the next three months after the Paris attacks, even cancelling out the January global market meltdown. This looks significant to me. Of course, if you want to cut the cost of the straddles, you can sell OTM calls and puts, thus effectively creating an inverse iron condor

The risk-return profile of the initial strategy looks as follows:


Essentially, in order for the trade to become profitable, the ETF has to move over 6% in either direction over the next month. Historical market data show that the 6% standard deviation is already priced into the straddle:

(Source: Google Finance. Calculations by author)

I think that, given the recent events in Nice and the geopolitical escalation in Syria, following the terrorist attack, will add volatility to the equation, and the options will be priced more expensively. Hence, in my opinion, the proposed options trade makes sense from a short-term investor's standpoint.