FX option implied volatility is currently experiencing a state of inertia, remaining close to long-term lows. This situation is indicative of a market landscape that is characterized by a notable lack of realized volatility, alongside an absence of any strong directional momentum. The combination of these factors has led to traders who are operating within this environment feeling comparatively unmotivated to incorporate price movement into their expectations.
In light of recent data releases, particularly the U.S. Consumer Price Index (CPI), it is noteworthy that overnight implied volatility had not been adequately adjusted to account for a possible surprise in the CPI figures. As a consequence of the data aligning closely with what was anticipated, the market's reaction was rather muted. Despite this, there was a slight weakening of the dollar in the aftermath of the announcement, though it remained within established trading ranges that have been observed over time.
The prevailing measures of FX realized volatility are extremely low, signifying minimal price swings throughout intraday trading. Interestingly, despite this prolonged period of low realized volatility, implied volatility continues to hold a premium over realized measures. This suggests that, going forward, the balance of risk and reward might be tipping in favor of those who are willing to buy options. This scenario offers beneficial opportunities for hedgers in search of cost-effective options for protection against potential market movements.
When analyzing specific positions, USD puts are emerging as the favored choice for long option strategies, particularly when paired against the euro. The euro remains an attractive vehicle for traders aiming to express bearish sentiments towards the dollar, especially for those looking at longer maturities in their strategies. Notably, risk reversal contracts— which serve as indicators of the directional risk premium associated with currency pairs— continue to bolster a positive outlook for the EUR/USD exchange rate.
On the other hand, the risk reversals in the GBP/USD pair are showing a tilt towards GBP puts in relation to USD calls, although there has been a gradual decrease in this bias. Current sub-2-week risk reversals are indicating a neutral stance, while the benchmark 1-month 25-delta contract shows a minor tilt of just 0.1 favoring GBP/USD downside over upside, a reduction from 0.75 observed in mid-July. This shift points towards a more even outlook for GBP/USD, suggesting a more balanced perspective on potential price movements in contrast to previous bullish sentiments.
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Patrick has been involved in the financial markets for well over a decade as a self-educated professional trader and money manager. Flitting between the roles of market commentator, analyst and mentor, Patrick has improved the technical skills and psychological stance of literally hundreds of traders – coaching them to become savvy market operators!