FX Options Insights
Implied volatility has faced significant pressure this February due to the lack of FX market volatility and swift directional shifts, both of which are critical for the performance of FX options. Despite recent losses, implied volatility remains substantially overpriced compared to historical realised volatility across various maturity dates and currency pairs. This indicates the potential for further declines as long as the FX market continues to exhibit uncertainty and remains within relatively stable ranges.
The 1-week USD/CAD implied volatility, expiring on March 4, has surged sharply by 2.0 points to the low 9s following U.S. President Donald Trump's renewed commitment to imposing tariffs on Canada by the stated deadline.
Meanwhile, the USD/JPY pair continues to test its lower bounds, leaving long-term holders of JPY calls increasingly frustrated by the lack of significant movement. The larger premium for JPY calls over puts in risk reversals aligns with the tendency for implied volatility to rise during spot lows.
In the EUR/USD market, trading iscentredd around 1.0500, with several key strike expiries limiting price action this week. Although the pair lacks a clear directional trend, risk reversals show a comparatively higher downside premium than upside strikes, particularly over extended timeframes. Implied volatility for 1-month options stands at 7.0, while 1-year implied volatility is slightly higher at 7.2, both elevated compared to the mid-February 2025 lows.
As February concludes, FX hedge rebalancing flows are expected to favour the USD, especially when measured against the EUR.
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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!