Implied volatility is one of the most tried and true methods for objectively measuring expected volatility in the spot market. Derived from currency options with different maturities, implied volatilities are used to help predict potential movements in the spot market and is one of the most popular strategies of systems traders and other professional hedge funds.
At its most fundamental, the basic and intuitive interpretation of this implied data is often the most telling for traders. Taken alone, a steady rise in the longer-term implied volatility ([B]the red line[/B]) is indicative of a strengthening trend; while inversely, a decline often reveals that a period of range or consolidation in spot is ahead or already in place. Additionally, the histogram or spread between the shorter and longer-term implied volatilities ([B]the blue colored bars[/B]) tells a different perspective. As the histogram rises, volatility is expected to pick up faster in the near future relative to the longer-term range. Ultimately, this increases the probability of a breakout scenario in the underlying currency.
[B]EURUSD[/B]
Short-term EURUSD vols continue well-above their medium term counterparts, and this clearly gives signal that options traders expect above-trend volatility through the coming two weeks of trading. The fact that 3-month vols have reached the double-digit zone only reinforces this fact, and markets are clearly gearing up for high volatility/breakout market conditions. As such, traders may be well advised to avoid range trading strategies through short-term trading. [B]SPOT PRICE[/B] [B]READING [/B] [B]1.5614[/B] [B]High Volatility/Breakout[/B] [B]LAST WEEK'S SPREAD[/B] [B]1.0[/B]
[B]GBPUSD[/B]
The outlook for the GBPUSD is unsurprisingly similar to that of the EURUSD, with a surge in overall volatility levels reflecting virtually frantic market conditions. 3-month volatilities are at their highest since the GBPUSD made its impressive reversal from the 2.1000 area, while 2-week vols are similarly elevated. We would look to pursue high volatility/breakout strategies in the coming weeks of trading. [B]SPOT PRICE[/B] [B]READING [/B] [B]2.0297[/B] [B]High Volatility/Breakout[/B] [B]LAST WEEK'S SPREAD[/B] [B]0.6[/B]
[B]USDJPY[/B]
What goes for the EURUSD and GBPUSD certainly holds true for the USDJPY through current market conditions, as the currency pair’s dive below the 100 mark has coincided with a surge in short-term volatility expectations. Given market indecision over potential Bank of Japan intervention, it is likewise unsurprising to note that 3-month vols are at their highest in many years. Such frantic market conditions tell us that it may be best to avoid any range-based USDJPY strategies in the weeks ahead. [B]SPOT PRICE[/B] [B]READING [/B] [B]100.17[/B] [B]High Volatility/Breakout[/B] [B]LAST WEEK'S SPREAD[/B] [B]1.2[/B]