FX Options Insights
Implied volatility in FX options is struggling to retreat from the peaks influenced by tariffs in early April, reflecting ongoing uncertainty and heightened realised volatility risk in currency markets.
Currently, FX markets are largely range-bound, with the USD finding stronger support above new long-term lows. However, traders should be wary of a potential USD weakness resurgence following the optimistic month-end fix in London.
Users of EUR/USD options are showing a stronger preference for EUR calls instead of puts. This keeps the risk reversals for options significantly favoured towards the upside rather than the downside. In early April, all expiry dates achieved 5-year high levels for upside strikes. Any pullbacks have been relatively mild, and longer dated expiries continue to hold these high levels (as illustrated in the chart). There is also notable demand accompanying these premiums, evidenced by a substantial purchase of 9-month 1.25 options last week. Those utilising barrier and trigger options have been adjusting their positions towards 1.2000. With implied volatility remaining elevated compared to pre-tariff levels and FX likely to maintain its range as trade agreements are negotiated before July 8, range binary options could become increasingly attractive. These options involve a small initial premium, which is a fraction of the total return, provided FX spot prices stay within two specified levels.
Short-term risks are anticipated from the Bank of Japan's policy announcement on Thursday; however, the slight rise in overnight expiry USD/JPY implied volatility suggests a general expectation of no changes. Risks from realised FX volatility linked to the U.S. jobs data released on Friday will become apparent if there's an increase in overnight expiry options starting Thursday.
Risk reversal options and broader trading activity indicate that the market remains cautious about further USD weakness, particularly against the EUR and JPY. Demand for USD put options commands the highest premiums, likely continuing to attract buyers at more favourable levels.
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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!