FX options reveal crucial EUR/USD topside indicators
Aug 29 (Reuters) -Forward looking FX options thrive on FX volatility and rapid directional moves, so their price action can reflect the perceived outlook for a currency pair. There have been some changes in the EUR/USD outlook in regard to further gains.
FX volatility is an unknown, yet key, part of an FX option premium, so implied volatility is used as a substitute. Higher implied volatility can therefore show increased, or an expected increase, in FX realised volatility, and vice versa.
Risk reversals charge an implied volatility premium for option strikes in whichever direction is perceived likely to generate the most FX volatility. A put is the right to sell a particular currency and a call is the right to buy it.
EUR/USD implied volatility increased as FX spot rallied to 13-month highs at 1.1201 last week and the benchmark 1-month 25 delta risk reversals flipped from a long standing EUR put to a EUR call premium - peaking at 0.4 on Monday - the highest topside strike premium since 2020.
However, while the spot setback/consolidation has weighed on implied volatility as expected, there's been a significant setback in that risk reversal premium, which has been sold at 0.1. Outright demand for EUR call options (topside strikes) around 1.1300 has also abated since last week, and the premiums are now falling.
Broader FX options are still keen to buy general FX volatility protection for next week's August NFP data, where a weaker than expected number would raise the possibility of a 50bps Fed rate cut in September and hurt the USD. Setbacks in topside EUR/USD options could therefore provide an attractive hedge.
For more click on FXBUZ
EUR/USD 1-month 25 delta risk reversals https://tmsnrt.rs/4g2yNbe
1-month EUR/USD FXO implied volatility https://tmsnrt.rs/3Xm7hhq
(Richard Pace is a Reuters market analyst. The views expressed are his own)
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