FX Options Insights: FOMC
FX options are forward-looking indicators of market movements, making their pricing highly sensitive to anticipated changes in volatility. While interest rate futures currently suggest no likelihood of a U.S. rate cut, option pricing for Wednesday's Federal Reserve meeting still factors in potential FX volatility, likely driven by the accompanying statement and press conference.
Overnight expiry, the shortest-dated option, aligns with the timing of the U.S. policy announcement. Implied volatility, a proxy for actual or realized volatility (which remains unknown), is critical in determining options premiums. A rise in implied volatility for overnight expiry typically signals an increased risk premium tied to the Fed. However, comments from Donald Trump on Tuesday regarding Iran have broadly contributed to heightened implied volatility, including for overnight options.As risk aversion eases and spot markets stabilize, implied volatility has pulled back from its earlier peaks by early Wednesday. Comparing current overnight expiry implied volatility to last week’s averages at a similar time may offer a more accurate measure of the prevailing Fed-related volatility risk premium, rather than relying solely on Tuesday’s and Wednesday’s opening levels.
For EUR/USD, overnight expiry implied volatility climbed from 11.0 to 13.5, resulting in a premium or break-even point of 65 USD pips, up from 53 USD pips in either direction. Similarly, USD/JPY’s implied volatility increased from 10.5 to 13.5, translating to 81 JPY pips compared to 65 JPY pips. Meanwhile, AUD/USD saw implied volatility rise from 11.0 to 15.0, with a premium or break-even of 59 USD pips versus 43 USD pips in either direction.
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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!