The Swiss franc floor, 2015

At a glance

What happened

From September 2011 the Swiss National Bank held the euro at or above 1.20 Swiss francs, buying euros in whatever size the market offered. On the morning of 15 January 2015 it abandoned the floor without warning. EUR/CHF fell from 1.20 to as low as about 0.85 within minutes, with almost no trading in between, before settling near parity. Stop-loss orders filled far beyond where they were set, retail clients ended the day owing their brokers money, and several brokers and a hedge fund failed.

Why it went wrong

A credible floor had pushed realised volatility close to zero, and everything downstream read that as safety. Value-at-risk models fitted to three quiet years produced tiny numbers, some brokers set margin well under one percent, and carry trades and structured products built up on the assumption the floor would hold. The floor did not remove the risk; it stored it and released it all at once. A stop-loss only promises to trade once a level is hit, not at that level, so in a gap clients got the next available price.

What it teaches

Low realised volatility is not the same as low risk, and a model fitted to a managed price describes the management, not the market. Leverage set against suppressed volatility is leverage against nothing. Stops, barriers, knock-outs and margin calls all assume prices move smoothly through levels, which is exactly what a sudden policy change breaks.

Key terms

Currency floor

A central bank commitment to prevent a rate falling below a level, held by intervening without limit.

Gap risk

The risk that a price jumps rather than moves through intervening levels, defeating stops and hedges.

Stop-loss order

An instruction to trade at the market once a level trades — an order, not a guaranteed price.

Negative client balance

An account whose losses exceed its deposit, leaving the client owing the broker money.

Suppressed volatility

Realised volatility held artificially low by intervention, which flatters every risk measure built on it.

Carry trade

Borrowing in a low-yielding currency to invest in a higher one — profitable until the exchange rate moves.

Where it sits in the course

Case studies like this one are used throughout risk management teaching, including FRM® preparation, as worked examples of gap risk, suppressed volatility and leverage. In OTC Learn the lesson runs in five steps: what happened, the position, why it broke, what it cost and what it teaches, followed by a worked example with the numbers. See the lesson outline.

The instruments behind it

OTC Learn lessons on the products this case turns on:

• FX ForwardLock in a future exchange rate
• Target Redemption ForwardA better rate that stops once you have won enough
• Barrier OptionA vanilla that switches on or off at a level