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French Election Hedges

20 April 2017 by Mark Holman

The first round of the French presidential elections happens this Sunday, and whilst we are fairly confident ultimately of a market friendly outcome, this cannot be guaranteed as we know all too well from other recent events.

The most likely outcome for this weekend is a final round that includes both Marine Le Pen and Emmanuel Macron, but what about Jean-Luc Mélenchon? Could his recent surge in popularity be underestimated by the polls? We know that nearly 40% of voters have yet to make up their minds.

Certainly a final run off that includes either Le Pen or Mélenchon is likely to gather a lot of press attention and focus investor anxiety. A run off that included both of them would ensure a worrying result.

Last minute hedging is usually an expensive process, which is why these known events are best discussed and planned for early, even if the result is a decision not to hedge.

We at TwentyFour have already taken some risk off in the run up to the political uncertainty, and whilst we are happy with the level of risk relative to our base case outcome, the recent sell off in the $ has enabled us to add another leg to our hedging strategy.

In this case a small option position on a weaker € versus the $ is our chosen tactic. Currency volatility is markedly lower than bond volatility and correlations between a weaker € and wider credit spreads on a negative event will be very strong, at least initially, which is what we would be looking to hedge.

With the €/$ back up close to 1.08, rather than 1.05 where it has recently been too, even a more market friendly French election outcome may not cost money if the $ finds some of its prior inertia. There is no such thing as a free option, but we think this is a cheap way of protecting some downside exposure to an event that may not be as clear cut as the polls suggest.

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