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]
The recent surge in price volatility has unsurprisingly forced a similar jump in implied volatility on forex options, and our range-breakout barometer continues to signal EURUSD breakouts. Short-term implieds are significantly higher than their longer-term counterparts, which typically signals that traders are gearing up for sharp price action through the following week of trade. This has likewise coincided with a rise in longer-term vols, which only reinforces our view. Thus we claim that the EURUSD is poised for further breakouts in price—leaving momentum based strategies as our most viable option in the days ahead.
[B]SPOT PRICE[/B] [B]READING [/B] [B]1.4636[/B] [B]Breakout[/B] [B]LAST WEEK'S SPREAD[/B] [B]0.72[/B]
[B]GBPUSD[/B]
A rise in EURUSD vols has unsurprisingly coincided with a similar jump for the GBPUSD, but it is worthwhile to note that the GBPUSD volatility curve is notably different than its euro counterpart. Namely, we see that both longer-term and shorter-term vols are a good distance from previous peaks, and furthermore the short-long spread is at a relatively low 0.22 percent. Such readings suggest that the GBPUSD is in fact more likely to remain rangebound in the week ahead. Of course, from a fundamental perspective, tomorrow’s Bank of England interest rate announcement could force noteworthy moves across GBP pairs.
[B]SPOT PRICE[/B] [B]READING [/B] [B]1.959[/B] [B]Range[/B] [B]LAST WEEK'S SPREAD[/B] [B]0.28[/B]
[B]USDJPY[/B]
The USDJPY is almost exactly unchanged from when we last wrote our report, and it has clearly remained within a very narrow trading range through recent price action. Implied volatilities have followed price action and traded lower, but we hesitate to claim that this signals range trading in the week ahead. From an absolute standpoint, the narrow 2week-3month implied spread suggests that few traders expect sharp price movements in the week ahead. Yet we likewise see that these conditions often prove to be the ‘calm before the storm’. It is difficult to predict when exactly the USDJPY may break out of its recent range, but we would recommend keeping risk levels tight on any short-term range trades.
[B]SPOT PRICE[/B] [B]READING [/B] [B]106.73[/B] [B]Range [/B] [B]LAST WEEK'S SPREAD[/B] [B]0.65[/B]