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] Implied volatilities on EURUSD forex options remain very elevated as price action remains extraordinarily choppy. Yet it is interesting to note that several weeks have passed and the currency pair remains almost exactly unchanged on a weekly basis. Subsequent moderation in implied volatilities on both long and short-dated options suggests that price action may slow in the week ahead, but we will maintain our outlook for “Moderate Volatility” nonetheless. Such conditions typically make intraday breakout strategies more profitable, while daily price movements may remain constrained/rangebound. [B]SPOT PRICE[/B] [B]READING [/B] [B]1.5739[/B] [B]Moderate Volatility[/B] [B]LAST WEEK'S SPREAD[/B] [B]0.27[/B]
[B]GBPUSD[/B]
Our outlook for the GBPUSD is unsurprisingly similar to that of the EURUSD. A recent moderation in implied volatilities on both long and short-dated options suggests that traders expect price action to slow in the weeks ahead. Given overall intraday volatility across major asset classes, intraday breakouts may prove worthwhile, but it seems as though price action may be stuck in a range until we see further shifts in directional bias. [B]SPOT PRICE[/B] [B]READING [/B] [B]1.9942[/B] [B]Moderate Volatility[/B] [B]LAST WEEK'S SPREAD[/B] [B]-0.91[/B]
[B]USDJPY[/B]
Overall market volatility has slowed since our last report, but it is interesting to note that short-term JPY vols remain exceedingly elevated through recent trade. Given a large short-dated/longer-dated spread of 1.42 percent, it seems as though options traders are gearing up for above-trend USDJPY volatility in the coming weeks. Risk reversals (not pictured) remain tame by comparison, however, and there is less directional bias in recent USDJPY options price action. All in all, we expect volatility to remain relatively depressed as markets consolidate. Yet we know that JPY price action can become extreme on our moment’s notice—leaving our outlook for “Moderate Volatility” until further notice. [B]SPOT PRICE[/B] [B]READING [/B] [B]101.45[/B] [B]Moderate Volatility[/B] [B]LAST WEEK'S SPREAD[/B] [B]1.02[/B]