FX Options Insights
G10 FX options are currently experiencing a period of subdued activity following a notable spike in volatility earlier in the week. Despite this temporary calm, market indicators suggest that participants are preparing for another potential surge in volatility. Realised fluctuations in foreign exchange rates have quieted down for the moment, and the relative weakness of the U.S. dollar appears to be on hold, but traders are nonetheless wary of what might come next. The market's implied volatility, which reflects traders' expectations of future price movements, has only slightly decreased. This indicates ongoing concerns about potential price swings. Furthermore, the elevated premiums on USD puts compared to calls maintain a significant presence in the market, specifically in the risk-reversal options that traders utilize to hedge against currency movements.
A particularly relevant example of this is seen in the benchmark EUR/USD 25 delta risk reversals, which shifted from a premium of 0.4 volatility points for downside protection to a premium of 0.6 volatility points for upside protection after the recent U.S. military actions against Iran last week. Similarly, the USD/JPY pair showed a recovery in its risk reversals, with 1-month risk reversals moving to 1.5, up from 1.15, indicating an increasing interest in securing downside protection against the U.S. dollar. As the demand for USD puts rises, options strategists are turning towards reverse knock-out (RKO) options, which present a cost-effective alternative to traditional vanilla puts. These RKO options allow traders to obtain downside protection as long as the dollar does not breach a predetermined knock-out threshold before the option's expiry, making them an appealing choice in the current market environment. Dealers in the marketplace report a robust interest in both the EUR/USD and USD/JPY pairs, as traders are actively looking for economical methods to position themselves in expectation of further weakness in the U.S. dollar.
The market's demand for volatility risk premium has been particularly strong as the July 3 expiry approaches, coinciding with the anticipated early release of June's U.S. non-farm payroll data. Traders are increasingly leaning towards USD put options, driven by concerns that a weaker-than-expected payroll number could ignite a fresh wave of dollar selling, especially ahead of the long U.S. Independence Day holiday weekend. Additionally, flows of capital into the market have revealed a growing interest in options that will expire after the July 9 extension of the U.S. tariff deadline. This forms another layer of FX volatility risk, though it is currently being priced significantly lower than the initial announcement of reciprocal tariffs from the U.S. made on April 2 of this year.
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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!