FX Options Insight
The foreign exchange (FX) climate is shifting from a state of uncertainty and associated FX volatility risk to a more cautious stance, which is stabilising spot markets and bolstering risk sentiment along with the USD, at least temporarily. The U.S. Federal Reserve's decision to maintain policy on Wednesday seems to have triggered a decline in FX option implied volatility, particularly with a sharp retracement in USD/TWD implied volatility contributing to this drop. Recall that the 1-month USD/TWD surged from 7.0 on Friday to record highs of 16.0 by Monday before falling to 11.0 in Asia on Thursday. Sub 3-month expiry implied volatility has been under pressure in G10 options, reaching lows since the initial trade tariff announcement on April 2.
Implied volatility for USD/JPY 1-month expiry has decreased to 11.35 from 12.7 since Wednesday, EUR/USD 1-month dropped from 9.5 to 8.75, and AUD/USD 1-month fell from 11.7 to 10.9. The GBP/USD 1-month expiry implied volatility continued to decline from Wednesday's peak of 8.6 to 8.0 after the Bank of England reduced UK interest rates to 4.25% as anticipated.
Risk reversals have also slightly eased, yet there remains a higher premium for USD puts compared to calls compared to late March against EUR, JPY, and GBP, indicating that the USD is still viewed as vulnerable against these currencies. This heightened USD put premium allows USD put options with RKO triggers to still provide a notable discount compared to standard vanilla USD puts.
Additionally, the premium for USD puts/CHF calls lessens the cost of USD/CHF topside options, which could become a favourable hedge if Swiss rates turn negative and/or the central bank intervenes to weaken the CHF. Range binary options are becoming advantageous for those seeking to profit from declining volatility while mitigating the unlimited risks associated with outright short volatility positions.
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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!