Turkish lira crisis rebound trade recommendation from Credit Suisse

Turkish
President Tayyip Erdogan
Murad
Sezer/Reuters

• 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.