How To Trade A Greek Event

4 days from now on the 30th of June, Greece will face a €1.5bn payment to the IMF. After having been pushed back by slightly over 3 weeks, this deadline now stands as a menacing giant over the shuddered Greeks.

This week's talks have seen no real progress, leaving the prospect of a Grexit, short for a "Greek Exit" from the Euro Zone, sky high.

Negotiators will realistically have until Monday to ink the paper which will allow withheld bailout funds to be released to the bankrupt nation. If no deal is reached by then, things will get very ugly very quickly.

In this short primer, we will prime readers for a Greek event - deal or no deal, Grexit or no Grexit. With the immediacy of this event risk, traders that fail to plan ahead risk having their books burnt by the volatility that is to come. In such a situation, preparedness is paramount.

Some Context

Earlier this week, hopes were rekindled when some ground was gained in negotiations between Greece and its creditors during the Eurogroup summit held on Monday. In the 2 days that followed, the Greek parliament was supposed to legislate a new deal which had earlier been proposed to the Troika.

Leaders met again on Thursday in an attempt to finalize an agreement, but it never happened. Today's meeting ended without a deal signed by both parities, bringing things back to square one even as the clock ticks closer to the day or reckoning.

The gambit by the radically defiant Syriza party has not yielded an inch. After their victory in Greece's parliamentary elections at the start of the year, things have only gotten worse for ordinary Greeks. The political infighting even within its government has been detrimental to the timely legislation of crucial new bills that seek to float the sinking ship.

All this means that it is now harder than ever for Greece and the Troika to be on the same page at the same time. The ensuing maelstrom has placed Greece on a knife's edge at almost every juncture as it now survives day to day.

Pensions are being plundered, Greek banks are facing record withdrawals with the risk of a full fledged bank run should Greece actually default.

Greek bonds of all types are now excluded from the ECB's collateral rules, removing one of the largest sources of demand for these securities. Although the ECB has stepped up emergency lending through the ELA to Greek banks, it will by no means serve as a long term solution to restore confidence in the domestic banking industry nor stem a systemic run on the Greek financial system.

Straits are dire.

Market Reactions

 10-year U.S. treasuries: Price action on treasuries have taken on a smilliar but not exact demeanor as bunds have. Yields have risen despite a sidewards trading stock market, mainly on the heels of anticipating a Fed rate hike.  Treasuires are a safe haven and will be sold on a re-risking trade and bid during times of risk aversion.   Chart by Business Of Finance

10-year U.S. treasuries: Price action on treasuries have taken on a smilliar but not exact demeanor as bunds have. Yields have risen despite a sidewards trading stock market, mainly on the heels of anticipating a Fed rate hike.

Treasuires are a safe haven and will be sold on a re-risking trade and bid during times of risk aversion. 

Chart by Business Of Finance

Firstly, let us briefly talk about the plausible reactions from the markets to the polar outcomes. While no one can say for sure, we believe these are the most likely scenarios which will unfold.

Depending on the specific timing of the event, reactions in the markets may vary in magnitude.

  10-year German bunds:  Bunds have hardly recovered from their worst ever selloff which started in April. In the last 2 weeks, bund yields have fallen from above 100bp as European equity markets saw a sharp rebound from their cycle lows.  Bunds will be one of the anchor points to weigh the post-outcome sentiment, apart from being very sensitive to risk itself.  Chart by Business Of Finance

10-year German bunds: Bunds have hardly recovered from their worst ever selloff which started in April. In the last 2 weeks, bund yields have fallen from above 100bp as European equity markets saw a sharp rebound from their cycle lows.

Bunds will be one of the anchor points to weigh the post-outcome sentiment, apart from being very sensitive to risk itself.

Chart by Business Of Finance

If the event happens over the weekends when the markets are shut, there will be huge moves the moment they reopen late Sunday evening. Futures and currencies will be the first to be traded and will offer a first glimpse into sentiment amongst traders.

Deal: Risk On

 EuroStoxx 50: The benchmark index of European stocks has rebounded sharply in the past week after testing a key support area. Having broken a down trend line, European equities (ex. Greece) might be poised for a take off, only hampered by the Greek roulette.  A positive outcome will be good for stocks, while a negative one will be bad, all very intuitively. Downside risks outweigh the upside, we should add.  Chart by Business Of Finance

EuroStoxx 50: The benchmark index of European stocks has rebounded sharply in the past week after testing a key support area. Having broken a down trend line, European equities (ex. Greece) might be poised for a take off, only hampered by the Greek roulette.

A positive outcome will be good for stocks, while a negative one will be bad, all very intuitively. Downside risks outweigh the upside, we should add.

Chart by Business Of Finance

A eleventh hour deal that prevents a default will likely be viewed as a good sign for both parities. We anticipate a rapid re-risking trade that will push risk assets sharply higher and safe havens lower. The primary beneficiary will broadly be European equities with Greek stocks standing to gain the most. 

European safe haven assets such as German bunds, French oats, Swiss bonds, and UK gilts will be the main losers. Expect these to be sold hard as hedges are taken off and capital gets recommitted to the long side of risk.

The euro should also see strong to moderate selling. We anticipate this after an initial spike on the good news. We believe this classic phenomenon, where cash is offered as risk is bid, will play out rather smoothly after the first few knee jerks.

Globally, there will be a good appetite for risk so expect most stock markets to trade in the green. Across currencies, we feel the impact will generally be muted apart from volatility in the euro which has a chance of partially spilling over to the U.S. dollar.

No Deal: Risk Off

A no deal event can be ambiguous and we suspect it will be. Negotiators may agree to further postpone the IMF payment deadline even if no agreement is reached (this has happened before). The worst case scenario being a technical default on the €1.5bn obligation in the absence of an agreement.

A no deal event will inexorably be viewd as negative for both parties. The de-risking trade accentuate after a week-long interlude. The severity of risk aversion depends on the specifics of the event.

A postponement of due payments will only be moderately bad for risk. We don't foresee heavily selling of risk assets or safe havens to be frantically sought. A knee jerk is to be expected but we feel the effects should generally be moderated.

A technical default on payment will be seen extremely negatively. As much as the market has discounted this probably, it is still considered a black swan in our eyes. Reaction here will be nothing short of impulsive.

Expect just about all risk assets including stocks, higher yielding currencies, bonds below IG to be dumped.

When such exposures cannot be liquidated, hedges will quickly build up leading to surges in volatility, prices of safe bonds, and cash.

European equities will be worst hit, peripheral bonds will be sold extremely hard. German bunds will be very bid along side other European safe havens.

Globally, the opposite of a the re-risking trade will unfold. The euro will be of particular interest. It is still an open question if flight to liquidity buying will overcome outright selling on negativity. Volatility however, is for certain.

Expect U.S. equities (one of the strongest) to be hit hard and treasuries to rally on a worst outcome. The U.S. dollar will be heavily sought.

Managing Uncertainty

Having discussed the most plausible market reactions, we complete the round table by discussing how traders should react to this uncertainty.

No one, not even insiders know what will transpire in the next few critical days. Managing this uncertainty is the job of all traders who are serious about protecting their books. We have spoken about the importance of diversification here and here.

Below are a few points we wish to highlight:

  • Avoid taking large positions which bet directionally.
  • Avoid holding too many positions.
  • As much as possible, square off all exposure before the weekends.
  • Take nibbles instead of bites when trading market moves.
  • Manage your own expectations on performance in the current climate.
  • Stay liquid, be nimble, and be ready to act on opportunities in the aftermath of the event.

We have vastly reduced our exposure to any single bet in recent times. Not only are most markets starting to trade sidewards, moves can be very idiosyncratic.

The risk to reward profile for holding large directional bets has deteriorated to a level where it becomes insensible.

Friday is the last trading day before we head into the weekends where a deal either happens or the nuclear option is exercised. We strongly advise traders to square off all positions and minimize exposure to any market. Portfolios of individual equity names should be hedged as much as possible via equity index futures and options.

In such circumstances, complexity often sounds the death knell for traders and portfolio managers. Simplicity bears with it elegance.

When markets move rapidly and when liquidity dries up, correlations tend to warp. Holding excessive positions across different markets may not be the wisest thing to do.

As traders, we also need to be opportunistic. Once clarity is restored, have the courage to act on a market that has not fully discounted whatever outcome there was. With proper risk management, this is a chance for profits to be made.

Lastly, managing expectations is an important element that is often sidelined. Its importance is only amplified in the current market climate when waters tend to be murky.