Implied volatility is one of the most tried and true methods for objectively measuring expected volatility in the spot market. Derived from currency options with different maturities, implied volatilities are used to help predict potential movements in the spot market and is one of the most popular strategies of systems traders and other professional hedge funds.
At its most fundamental, the basic and intuitive interpretation of this implied data is often the most telling for traders. Taken alone, a steady rise in the longer-term implied volatility (the red line) is indicative of a strengthening trend; while inversely, a decline often reveals that a period of range or consolidation in spot is ahead or already in place. Additionally, the histogram or spread between the shorter and longer-term implied volatilities (the blue colored bars) tells a different perspective. As the histogram rises, volatility is expected to pick up faster in the near future relative to the longer-term range. Ultimately, this increases the probability of a breakout scenario in the underlying currency.
| EURUSD Short-term implied volatilities on EURUSD options have fallen significantly through the past week of currency trading, which suggests that relatively few traders expect significant breakouts through short-term price action. As such, we downgrade our EURUSD outlook from one of “High Volatility” to “Moderate Volatility” through this week and the next, but it serves to note that longer-term vols remain very elevated despite their sharp drop. Intraday volatility strategies may continue to function well, but range trade strategies may prove profitable on daily bars as markets consolidate following recently extreme price action. | ||||||||||
| SPOT PRICE | READING | |||||||||
| 1.5419 | Moderate Volatility | |||||||||
| LAST WEEK'S SPREAD | ||||||||||
| 0.98 | ||||||||||
| GBPUSD Much like we see in the EURUSD, short-term volatility on GBPUSD options has fallen quite dramatically through the past week of trading. Given a sharply negative short-medium term implied volatility differential, it seems as though options traders are gearing up for a slowdown in overall GBP price action. As such, we may look to employ range trading strategies in the coming two weeks of British Pound currency trading. It does serve to note, however, that markets remain in very fragile condition; elevated medium term vols will encourage us to keep risk tight on any relevant range trades. | ||||||||||
| SPOT PRICE | READING | |||||||||
| 1.985 | Range | |||||||||
| LAST WEEK'S SPREAD | ||||||||||
| 0.51 | ||||||||||
| USDJPY What goes for the EURUSD likewise holds for the USDJPY. Short-term JPY options are trading just above their elevated longer-dated counterparts—suggesting that traders are geared for moderate volatility in the days ahead. Risk reversals (not pictured) are nonetheless at their most extreme since August, 2007, which can mean one of two things. On the one hand, we may see markets consolidate—much like they did in August—as risk reversals and price stabilize through short-term trading. A second interpretation is that we may see further USDJPY losses through the coming weeks of trading. If price action unfolds as it did in August of last year, we may see the pair stick to short-term range trades before resuming its longer-term downtrend. | ||||||||||
| SPOT PRICE | READING | |||||||||
| 100.87 | Moderate Volatility | |||||||||
| LAST WEEK'S SPREAD | ||||||||||
| 1.15 | ||||||||||
