Are options under-pricing US election risk to USD/JPY?
Oct 15 (Reuters) -When comparing FX option volatility risk premiums with their fair value measures for expiry dates, which include the U.S. election on November 5, USD/JPY stands out as being potentially under-priced.
FX volatility is a key, yet unknown parameter of an FX option premium, so dealers use implied volatility as a stand in. If actual volatility matches implied volatility over the life of that option it should cover the premium, with the disparity potentially making FX volatility a tradable asset. Implied volatility therefore represents the expected realised volatility and should demand an additional premium if its expiry includes a high volatility risk event, such as an election.
Historic volatility is actual/realised volatility over a particular time frame in the past and can provide a fair value measure upon which to gauge implied volatility.
USD-related implied volatility for benchmark 1-month options saw a significant increase when its expiry included the US election result. In the majority of cases implied volatility remains elevated and trades with a strong premium to 1-month historic volatility to highlight that "event risk" premium -- but not USD/JPY.
One-month USD/JPY implied volatility increased from 12.5 to 13.75 when its expiry initially captured the U.S. election, but has retreated to 11.8 since. Mid-September and two-month lows aren't far away at 11.3, while that fair value one-month historic volatility measure remains elevated around 12.8.
One-month expiry also includes the next monthly U.S. jobs report and U.S. policy decision - both of which would historically have increased realised USD/JPY volatility. Other post 1-month expiry dates are looking mpre attractive after setbacks, too.
Related nL1N3LQ0AQ. FX options wrap nL1N3LQ0J3
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USD/JPY 1-month expiry FXO implied vs 1-month daily realised volatility https://tmsnrt.rs/3NrKuLy
(Richard Pace is a Reuters market analyst. The views expressed are his own)
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