The euro is trading five big figures higher compared to the last Market update #19 on October 17. Although we had anticipated a small recovery, we initially only assumed that the 200-day line would be reached. However, this important average line offered no resistance at all. As a result, the euro continued to rise and implied volatilities fell further than originally expected.
The lower table shows quotes of EURUSD impl vols at 06:05 NY time. The ATM implied vols have not just fallen, they have been beaten down in recent weeks. The last time we saw levels just above 6% was in February 2022, before the Russian-Ukrainian war began.
The dramatic fall in implied volatilities can also be seen in the following comparison with the last observation date. Over the entire almost flat term structure, the EURUSD options market is trading between 1.05 and 1.30 percentage points lower. These low levels were outside my expectations, but they may now offer opportunities for re-entry into a long vol position or hedging strategies for dollar buyers.
Nevertheless, you have to accept the market result for the time being. In this respect, the short maturities over the next one to two months are perhaps less interesting than they appear at first glance. The end of the year is not far away and all risks seem to have virtually disappeared, especially with regard to the S&P 500 based Volatility Index. In the absence of any particular news, it can therefore be assumed that implied volatilities will continue to trade sideways or even lower.
The further development of the euro will of course be decisive for the options market. Although the picture is already slightly overbought, above the minor 1.0945/65 resistance zone the currency pair could easily move up another one or two big figures. In this respect, a little patience could pay off for active traders before too much time value is lost over the holidays.
Players with a real need to hedge underlying transactions may already interpret the situation somewhat differently. The euro is trading in the upper half of the annual 1.0448/1.1276 trading range and FX options are cheap. Ultimately, the market still sees risk on the downside, albeit at a somewhat less pronounced level. The EURUSD Volatility Surface continues to show a clear downside skew, even if the risk reversals have narrowed somewhat.
Overall, I would therefore advise investors who need to hedge to use the six- and nine-month maturities. With both tenors, the ATM strikes are well above the interesting 1.1000 treshold (forwards: 6m/89 pips, 9m/136 pips). However, it could make sense not to hedge the entire nominal value in the first step, but only 50%, for example. This gives you the opportunity to become active again at higher spot levels. However, this does not solve the dilemma that you always have a position with real flows, with or without a hegde.*
Good luck,
Sebbo
(*reminder: my content is intended to be used and must be used for informational purposes only. It is very important to do your own analysis before making any investment based on your own personal circumstances.)
Great analysis! I wasn’t aware of that the EURUSD imp. vol. had dropped so sharply recently. Do you think it’s fair to say that has helped fuel the EURUSD upwards price action?