FX Options Insights
Implied volatility for FX options has become more negatively correlated with the USD, easing from Monday's peaks as the recent dollar's decline stabilises. Nevertheless, implied volatility is still significantly above last week's pullback lows, highlighting the persistent uncertainty and potential FX risks ahead. Risk reversals are an important sign of directional risk in FX markets, showing the extra cost that dealers think is needed for options that they believe are more likely to have bigger price changes. For several currencies, this extra cost suggests that the USD may weaken. For several currencies, this premium points towards USD weakness.
EUR/USD risk reversals have been trading at their highest premiums for EUR calls versus USD puts since 2020, while GBP/USD risk reversals have hit their highest premiums for GBP calls against USD puts since the financial crisis. Meanwhile, USD/JPY risk reversals continue to exhibit a solid premium for JPY calls versus USD puts, although it is below its recent peaks. There has also been consistent demand for hedging against the risk of more significant declines using outright JPY calls versus USD puts.
One factor behind the demand for JPY calls against USD puts is the concern that foreign exchange rates could be leveraged as a negotiating tool in trade discussions between the U.S. and several Asian nations. These concerns intensified after reports surfaced that the U.S. and South Korea discussed FX matters in early May, prompting increased demand and premiums for USD/KWN options, with USD puts once again taking precedence.
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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!