The “Quant” section of our Morning Slices report is designed to give a quick snapshot of market sentiment as it relates to forex options markets and currency correlations. We use options markets as a concrete gauge to trader demand, while our correlations studies tell us what kind of assets are moving the currency market. So what do these tables tell us?
[B]DailyFX Volatility Index Percentiles[/B]
Our DailyFX Volatility Indices are a measure of volatility expectations through specific time frames. In forex options markets, the price of an option depends on several different factors. The most obvious is always going to be the strike price—the price at which the put or call option may be exercised by the purchaser. Another very important determinant of options prices is volatility expectations of the underlying currency pair—also known as the Implied Volatility.
Our DailyFX Volatility Index Percentiles measure the implied volatility levels of the four major currency pairs plus the Canadian Dollar. The higher the number, the more likely we are to see strong movements in price. This number tells us where current implied volatility levels stand in relation to the past 90 days of trading. We have found that implied volatilities tend to remain very high or very low for extended periods of time. As such, it is helpful to know where the current implied volatility level stands in relation to its medium-term range.
[B]Risk Reversals
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Risk reversals are a measure of trader sentiment as seen through options prices. Volatility is a major determinant of options prices. Risk reversals measure the difference between volatility levels for out of the money Puts and Calls. If demand for out-of-the-money call options is stronger than demand for the equivalent puts, options traders are on aggregate bullish a given currency pair and are willing to pay more for calls. This makes Risk Reversals positive.
The percentiles you see in the table above measure the level of risk reversals as they relate to their 90-day range. If the percentile is close to 100%, then markets have grown very bullish the currency pair as it relates to the past 90days. If markets are growing increasingly bearish, then this number will likely be closer to 0 percent. This way we can get a good grasp of which way sentiment has been leaning in either direction.
[B]Market Movers[/B]
Our “Market Movers” section takes a simple look at cross-market correlations and key currencies. The correlations measure the extent to which the currencies move in the same direction as any of our three indices in the past 30 days. A correlation of 1.00 would signal that the currency moves perfectly in tandem with the index, while a correlation of -1.00 would signal that they move in exactly the opposite direction. A correlation of 0.00 shows that they have no numerical link.
We compare currencies to the Reuters CRB Commodity Index as a proxy for all commodity prices, the US S&P 500 equity indices for major global equities, and Rates as a measure of relative interest rate expectations. The Rates index measures the difference between 1-year interest rate expectations for a given currency pair. Thus for the Euro/US Dollar, we subtract 1-year US Federal Reserve rate forecasts from 1-year European Central Bank expectations and compare that to the EUR/USD. The stronger the correlation, the more interest-rate sensitive markets have become.