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]
A sharp drop in short-term vols reflects a nearly-universal slowdown in global economic event risk, and the Euro-US Dollar currency pair may subsequently remain in a relatively small range through short-term trading. Indeed, implied volatility on EURUSD forex option shows that 2-week options currently fetch 0.63 percentage points less in volatility than their 3-month counterparts. Such conditions have historically signaled relatively little volatility for the EURUSD pair and leave range-trading strategies as the most attractive option through short-term trade. [B]SPOT PRICE[/B] [B]READING [/B] [B]1.4712[/B] [B]Range[/B] [B]LAST WEEK'S SPREAD[/B] [B]-0.35[/B]
[B]GBPUSD[/B]
The outlook for the GBPUSD is, as usual, relatively similar to that of the EURUSD from a volatility perspective. Indeed, a negative implied volatility spread shows us that options traders predict that short-term price volatility will fall below its medium term average. Viewed in this light, we would prefer to look for strong range trading opportunities for the GBPUSD in the days ahead, as substantial breakouts are less likely in such market conditions. [B]SPOT PRICE[/B] [B]READING [/B] [B]1.9416[/B] [B]Range[/B] [B]LAST WEEK'S SPREAD[/B] [B]-0.60[/B]
[B]
USDJPY[/B]
The USDJPY is the only one of our three major currency pairs that currently carries a positive short term-medium term implied volatility spread through time of writing. Yet a recent drop in absolute volatility levels likewise suggests that traders expect price action to slow in the USDJPY. Given that the USDJPY typically carries a negative correlation with sharp volatility, current market conditions arguably leave a modestly bullish bias for the risk-sensitive pair. As with the other pairs, we may favor range-trading opportunities for the USDJPY through the short term; current implied volatility levels make breakouts somewhat less likely. [B]SPOT PRICE[/B] [B]READING [/B] [B]108.08[/B] [B]Range[/B] [B]LAST WEEK'S SPREAD[/B] [B]0.97[/B]