FX Options Insight
The price movements in the FX options market indicate a growing risk appetite and a more stable FX approach, while also acknowledging the potential for increased USD weakness, highlighted on Monday following the downgrade of the U.S. credit rating.
Among G10 FX, EUR/USD and its option premiums experienced the largest increase. Risk reversals had already shown strong support below the 5-year highs for EUR calls over puts from early April, indicating that the upside is the more vulnerable segment of the market. As a result, recent spot gains enabled EUR/USD implied volatility to recover, with the benchmark 1-month expiry bouncing back to the mid 8's, fully reversing the gains influenced by tariffs post-April 2 from 7.0 to 13.0.
In contrast, the implied volatility of USD/JPY experienced only modest advancements following its role in last week's initial rebound. The benchmark 1-month expiry climbed to 11.7 from a low of 9.5 on May 13 (with a peak of 16.0 post-April 2 tariffs). Risk reversals continue to show a strong preference for USD/JPY downside over upside options.
The premium for USD puts is also notable against CHF and GBP, reflecting the perceived weakness of the USD against these currencies. USD/KRW implied volatility remains high, with risk reversals at recent multi-year highs for USD puts due to heightened concerns over exchange rates becoming part of trade negotiations following discussions between the nations.
While the current trend of USD weakness might eventually revert to a phase of consolidation—especially as trade discussions continue—the overall sentiment in the FX options market stays cautious. Pricing dynamics suggest that market participants are preparing for deeper and prolonged downside risks to the USD.
Moreover, FX options do not expect the anticipated rate cut by the Reserve Bank of Australia to 3.85% on Tuesday to trigger any significant increase in FX volatility.
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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!