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 A cross-market drop in volatility has unsurprisingly left short-term EURUSD vols significantly lower on the week, and such conditions favor further rangebound price action for the currency pair. Our short-long implied volatility spread has reached its lowest levels since the turn of the year, and such a shift shows that options traders do not expect major EURUSD moves in the coming weeks of trade. That said, absolute implied volatility levels remain elevated from a historical standpoint, and such a lull in realized volatility may simply be the calm before the eventual storm. Favor range trading strategies if conditions remain unchanged | ||||||||||||
| SPOT PRICE | READING | |||||||||||
| 1.4577 | Range | |||||||||||
| LAST WEEK'S SPREAD | ||||||||||||
| 0.85 | ||||||||||||
| GBPUSD Our outlook for the GBPUSD is unsurprisingly similar to that of the EURUSD, with an inversion in the short-long dated implied volatility spread suggesting that trading ranges will remain narrow in the week ahead. A drop in the absolute levels of implied volatility likewise supports the rangebound trading scenario, and it seems as though breakout strategies may prove ineffective in the week ahead. | |||||||||||
| SPOT PRICE | READING | ||||||||||
| 1.9648 | Range | ||||||||||
| LAST WEEK'S SPREAD | |||||||||||
| 0.22 | |||||||||||
| USDJPY The implied volatility spread on the USDJPY suggests that, unlike the EURUSD and the GBPUSD, the yen could see moderate volatility in the week ahead. A positive spread tells us that options traders are paying a volatility premium on shorter-dated expirations, and as such they predict that short-term volatility will be above its medium-term average. Such factors tell us that the USDJPY may in fact break out of its recent range through short-term currency trading. Given the fact that the USDJPY generally shows a negative correlation with cross-market volatility, this leaves a moderately bearish outlook for the currency pair. | |||||||||||
| SPOT PRICE | READING | ||||||||||
| 108.18 | Moderate Volatility | ||||||||||
| LAST WEEK'S SPREAD | |||||||||||
| 0.43 | |||||||||||
