FX Options Insights 22/01/25

The recent shift in the broader implied volatility for FX options has brought relief to investors as the expected impact of tariffs didn't materialise, easing concerns in the market. The EUR/USD pair saw a significant decline, while profitable short positions taken at higher levels in various currency pairs proved lucrative. Notably, the implied volatility for 1-month EUR/USD dropped to the low 7s from the low 9s, with the 1-year volatility also showing a decrease from 8.0 to 7.2 before seeing a rise in demand. Similarly, the 1-month GBP/USD and AUD/USD volatilities saw reductions, indicating a more stable market environment.

Late on Tuesday, President Trump's announcement of potentially imposing 10% tariffs on China from February 1 had a muted effect on the FX options market. The implied volatility for 1-month USD/CNH continued its decline, contrasting with the volatility seen in USD/CAD, which surged following threats of tariffs on Canada. Despite an initial drop in USD/CAD volatility, support around 8.0 emerged due to the increased demand and the need for strike protection post-February 1.

Conversely, USD/JPY's implied volatility hit long-term lows across different expiry terms, presenting opportunities for hedging against potential scenarios like the Bank of Japan's interest rate decisions. With a 10% chance of no interest rate increase by the Bank of Japan, topside options are seen as a cost-effective hedge in the current market landscape. This evolving volatility in FX options underscores the importance of strategic positioning and risk management for investors navigating these intricate market movements.