FxVolWeekly
12 - Nov - 2021
Short-Dated IV/AV Spreads
GBPJPY and USDJPY are once again showing up as the most expensive-looking at options prices based solely on the spread between implied vs. actual volatilities. GBPUSD is now in third place while at the same time GBPCAD is showing up as the third least expensive using the same IV/AV metrics. The cheapness of GBPCAD is working off the assumption that the price action in USDCAD will be correlated to GBPUSD and this assumption may not be fully warranted. So on a purely relative value basis, GBPCAD looks attractive. Having said that, however, GBPCAD has been the most mean-reverting FX pair and each time it has tried to break either higher or lower it often reverts back to its average value.
The MT GBPCAD chart above shows both the implied vol rise in the back end of the curve and at the same time the break lower in the GBPCAD out of the sideways consolidation pattern. Implied vols rose more sharply in the back end of all of the GBPUSD and its major crosses as seen in GBPCAD but also in EURGBP as well.
Three-month EUR implied vol breaks the downward trend line and the gap between the implied and actual vol remains wide. This is understandable given the spot breakthrough key downside support.
EUR daily dispersion is now rising from a low level. The implication is that the directional move lower is only in its early stages.
EUR actual vol remains bid with the two-week realized running in excess of the six-week measure.
Our longer-term GBPUSD dispersion indicator shows signs of rising still further and the implication is that the down move in GBPUSD is not over yet. The rise in longer-dated GBP implied vol indicates to us that the market is now pricing in a higher risk premium for sterling assets following the failure of the BoE to tighten.
Like EURUSD actuals EURJPY also remain bid and like the rest of the JY crosses GBPJPY and CADJPY the back end of the curve has move up faster than the short dates.
The GBPUSD 3-month and 6-month implied vol chart from 2017 is above and here too can see we have taken out the falling implied vol trend.
Above is the 3-month and six-month EURGBP implied vol chart back to 2017; and here too you can see the break in the falling trendline. As you can guess the skew in EURGPB has moved back better bid for EUR calls over and are now registering as just fair value on our metrics (neither cheap nor expensive). A number of systematic CTAs have got long EURGBP and this is supported to some extent by our daily momentum indicator which may well have found an important bottom.
EURCHF may have found a short term bottom as well. The back end of the EURCHF curve is expensive in our view in relation to the actuals. Longer-dated butterflies or condors spread to the upside may well look attractive. E.G. +1.05 -1.08 -1.11 and +1.14 in the six month expiration.
If EURCHF has found a bottom then USDCHF can rally faster to the upside. We have broken the hourly trend line in the chart above and our short term momentum indicator has turned bullish. Broadly speaking we are sympathetic to the short-term $-bullish sentiment in the near term, but we are sceptical about the sustainability of the dollar rally long term. A stronger dollar means a tightening of global financial conditions and is potentially risky in the current global context with China having property-related credit issues.

Translating Implied Vol to % expected move
One common question that is often asked about option pricing is: given a known market value for implied volatility (IV in the column above) how much would we expect the FX rate or commodity to move over a certain period of time. Volatility is according to the model proportional to the inverse of the square root of time. So, to figure out how much price movement is expected by a 5% implied volatility on a daily basis we need to take the square root of the number of trading days in a year. Using 256 as that number the square root of 256 = 16. So, based on a 5% implied vol we would expect a one-day move of approximately 0.31%. For a one week move, we need to divide the implied vol by the square root of 52 (the number of weeks in a year). So, the expected one week move would be 0.69%. Strictly speaking, this is a one-standard deviation move over the time period in question. The option pricing model assumes (roughly) a one-standard-deviation move to cover approx 2/3 of the price action and a two standard deviation move approx 95.4%. Higher volatilities will imply a greater degree of price dispersion or a higher deviation from the average observed values.
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Research Director