What next for the Euro if the US decides to inflate its way out of a debt crisis?

What next for the Euro if the US decides to inflate its way out of a debt crisis?

by Hari P Krishnan

This time with EUR/USD FX rate as our focus.

The euro acted as a safe haven during April’s tariff wars and, if the US decides to inflate its way out of a debt crisis, it could go significantly higher.

The following structure in Figure 1, which requires some explanation, acts as a low-cost way to play EUR upside, with bounded risk.

Combine Options Structure on CME Euro Futures
Figure 1: Combine Options Structure on CME Euro Futures

We've bought a broken put fly on the euro to “fund” the purchase of an out of the money call. If the spot EUR/USD rate stays relatively fixed, the forward will roll down into strike zone for the fly, offsetting the cost of the call.

Conversely, if the euro spikes higher, we capture a decent poercentage of the upside. Figure 2 is illustrative, as we see long flat stretches (blue line), with the occasional jump higher. The graph was taken from the “Strategy” module in Copilot, “Backtest” tab.

Options Structure vs Rolling Futures. Taken from the "Strategy" module in Copilot, "Backtest" tab
Figure 2: Options Structure (blue) vs Rolling Futures (gray). Taken from the "Strategy" module in Copilot, "Backtest" tab

While median weekly returns are close to 0%, the histogram (Figure 3), taken from the “Strategy” module in Copilot, “P&L Dist” tab, is strongly positively skewed. This drives performance.

Historical Weekly Performance of Options Structure; this was taken from the "Strategy" module in Copilot, "P&L Dist." tab
Figure 3: Historical Weekly Performance of Options Structure

As always, this is not a trade recommendation, simply a case study.


About the author

Hari P Krishnan
Hari P Krishnan

Hari P Krishnan has 25 years’ experience in financial markets, with over two decades as a portfolio manager. Formerly a PM at Doherty Advisors in New York, a fund manager at CrossBorder Capital in London, and an Executive Director at Morgan Stanley, he now manages or advises separately managed accounts at SCT Capital in New York.

Hari is the author of The Second Leg Down on regime-based hedging, and lead author of Market Tremors: Quantifying structural risks in modern financial markets. He holds a BA in maths from Columbia University, a PhD in Applied Math from Brown University and was a Postdoctoral Research Scientist at the Columbia Earth Institute.