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While the foreign exchange (FX) volatility, which is crucial for the functioning and pricing of options, has been notably absent for a considerable duration, the current low levels of implied volatility are increasingly creating a more favorable environment for options buyers. The recent government shutdown in the United States has resulted in a reduction of concerns surrounding data-driven FX volatility risks. This includes significant economic indicators such as the U.S. jobs report, which is eagerly anticipated each month. Consequently, the shutdown has compounded the already substantial implied volatility in shorter-dated options expirations, which further tightens the market dynamics. However, it's essential to recognise that lower implied volatility signifies that less actual or realised volatility is necessary for traders to hit break-even points and subsequently generate profits, even within the bounds of well-known trading ranges. This situation presents an opportunity for traders who can capitalise on significant price movements without needing extreme fluctuations.
A notable observation is that the implied volatility for one-week and one-month expiries of the EUR/USD currency pair has been identified as relatively inexpensive when juxtaposed with the historical volatility numbers observed during the same timeframe. Moreover, one-week expiry implied volatility for the USD/CAD pair has plummeted to as low as 3.75, indicating levels that haven't been experienced since the early stages of the Covid pandemic in 2020. This notable decline in implied volatility across various currency pairs points to a potential shift in market sentiment and expectations. There are, however, specific instances where implied volatility remains elevated, particularly in relation to one-week JPY-related options. This spike in implied volatility is attributed to the risks surrounding the realised volatility linked to the upcoming leadership election of the Liberal Democratic Party (LDP) in Japan this weekend, which carries the potential for significant market impact based on the election's outcome. Additionally, the one-month implied volatility for USD-related options is bolstered due to its impending expiry coinciding with the critical Federal Reserve policy decision scheduled for October 29. Simultaneously, one-month expiries in JPY-related currency pairs benefit from the anticipated Bank of Japan policy decision on October 30. In this case, options traders are hedging against a higher perceived risk of an interest rate hike that could lead to gains in the Japanese yen, reflecting the intricate interplay between monetary policy decisions and FX market volatility dynamics.
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Patrick has been involved in the financial markets for well over a decade as a self-educated professional trader and money manager. Flitting between the roles of market commentator, analyst and mentor, Patrick has improved the technical skills and psychological stance of literally hundreds of traders – coaching them to become savvy market operators!