Traders are placing options bets that European Central Bank policymakers will unexpectedly cut interest rates by 25 basis points at some point this year, a move that runs counter to the prevailing market consensus. Multiple large bets using option strategies linked to the three-month Euribor rate have emerged this week. If the ECB does indeed cut rates, these trades stand to generate total returns of €32 million (approximately $38.3 million), representing a staggering 12-fold payout.
This activity appears particularly contrarian against a backdrop where inflation is already slightly below target and the market's long-term expectation is for the ECB to hold borrowing costs steady this year. Although policymakers are highly likely to keep rates unchanged at their first annual meeting next week, the recent sharp appreciation of the euro has sparked discussions about the possibility of further easing, introducing a new variable for policymakers to consider.
"From a risk asymmetry perspective, rate pricing for 2026 looks very attractive," said Kim Crawford, Global Rates Portfolio Manager at J.P. Morgan Asset Management. "The market is not currently pricing in any rate cuts, and if the ECB acts, the direction can only be a cut, not a hike."
While occasional contrarian bets in the market are not uncommon, the sudden surge in such activity may signal a shift in sentiment. Following the euro's significant appreciation against the dollar, Austrian Central Bank Governor Martin Kohr warned that if the exchange rate rise is substantial enough to lead to a downward revision of inflation forecasts, the possibility of a rate cut would need to be considered, after which bets on further easing increased.
A stronger currency reduces import costs, thereby easing upward pressure on prices. Earlier this week, the euro climbed to its highest level since 2021 as concerns about U.S. policy direction weakened the dollar. Money markets currently price in only about a 25% probability of a rate cut within the year.
The market also expects the ECB's 2% deposit rate to be maintained until early next year, continuing the policy stance held since the last rate cut in June of last year. "I don't think euro/dollar volatility will cause the ECB to shift to a more dovish stance," said Lucile Flight, Managing Director of Rates Trading at Barclays. "ECB policy will remain firmly stable."
The uniqueness of these option trades lies in their structure, which lowers transaction costs by simultaneously betting that policymakers will not hike rates. A 25-basis-point rate hike by the ECB would result in a loss of approximately €15 million; a 50-basis-point hike would amplify the loss (including premium costs) to €35 million. However, most traders typically do not hold such positions until expiration.
Driven by these large bets, trading volume for call and put option contracts expiring in December surged to nearly 600,000 contracts on Wednesday, more than double the volume of the second-most active trading day. Some traders are also using options to bet that the ECB will hold rates steady.
One such bet targets unchanged rates until mid-year; if this scenario plays out, the €1.9 million investment would yield a 2.5x return. Barclays' Flight noted that the expectation for unchanged rates is reasonable, given that inflation futures markets show no downward pressure and the impact of energy prices will be more significant than exchange rate movements. "This completely rules out the possibility of a rate hike," she said. "But I see no basis for betting on a rate cut on top of that."
Comments