J.P.Morgan Identify A Couple Of Eurodollar Vs. Euribor Option Plays

J.P.Morgan writes “we see attractive cross market opportunities in the EUR money market sector versus USD. Specifically, we expect an outperformance of Euribor yields versus USD Libor both in a rally and a sell-off. In terms of current pricing, the USD OIS curve is pricing around 82bp and 196bp of cumulative hikes at the July and December meetings and an easing of around 60bp over the course of 2023 by the Fed. We do not challenge this inversion given the risk of recession in the U.S. in 2023.”

• “The options market is, however, pricing a higher USD volatility versus Euribor suggesting that while the Euribor outperformance in a sell-off scenario is somewhat priced in, the expected outperformance in a rally is mispriced, in our view. Therefore, we find bullish expressions of this cross-market underperformance (USD-EUR) to be favourable in H223.”
• “Conversely, we see risk of further aggressive rate hikes by the Fed in H222 relative to what is priced currently. We cannot rule out a scenario where still strong labour markets and solid inflation data forces the Fed to take policy rates well into restrictive territory (say around 3.50-4.00%) even though growth stutters in the coming months. The peak of the USD OIS curve is currently around 3.50% and near-term risks support higher yields. In any case, we would expect an underperformance of ED H222 yields relative to Euribor given larger recessionary risks in Europe. To this effect, we favour buying OTM USD Sep ‘22 (or Dec ‘22) puts versus selling Euribor puts at a small upfront premium. We prefer to express this view via deep OTM structures (say around 25bp or more).”
• As such, they recommend:
• Buying 1,000 EDU2 96.3125 puts vs. selling 1,000 ERU2 99.0000 puts at a net cost of 3 cents.
• Buying 1,000 98.625 Sep ‘22 1-Year Euribor midcurve calls vs. selling 1,000 96.75 Sep ‘22 1-Year Eurodollar midcurve calls at flat.