FXO Market Update - Jan 21

The year has started with a healthy risk sentiment which in combination with supply of vol from corporate hedging have put pressure on vols. Corporates are usually sellers of vol in their hedging structures and tend to put on the hedges for the full year in January. This supply of vol can be significant and usually fades when we go into February.

We have seen a sharp sell off today with EURUSD 1 year vol down to 6.1, compared to 6.65 two weeks ago, and USDJPY 1 year down to 6.5, from 6.9 at the start of the year. 1 year vols now trades at the lowest levels since the pandemic hit the market in March last year. There is still a bit of way to go before we see the levels from January 2020, but keep in mind those low levels were reached after a very quiet 2019.

We think it is a good time to buy some longer dated options as a core position for 2021, now after the last days of sell off.

With the current vol, a 1 year at-the-money forward in EURUSD cost 305 pips, for either a put or a call. In USDJPY, a 1 year at-the-money forward cost 275 pips. For example, with current spot and forward the break even for a 1 year EURUSD at-the-money forward call will be just above 1.2500.

Buy 1 year 1.2215 EURUSD call or put
Cost 305 pips

Buy 1 year 103.08 USDJPY call or put
Cost 275 pips

Spot ref. EURUSD 1.2110, USDJPY 103.60

• The Top/Bottom charts shows the top 5 and bottom 5 values/changes for at-the-money vol, risk reversal (RR) and risk premium of the 45 currency pairs we are tracking.
• Risk premium: Implied (Imp) minus realized volatility. A positive risk premium means implied volatility trades above realized volatility, i.e. the implied volatility can be seen as “rich”.
• Change: The difference between current price/volatility and where it closed 1w ago.

FX Options Trading:

You should be aware that in purchasing Foreign Exchange Options, your potential loss will be the amount of the premium paid for the option, plus any fees or transaction charges that are applicable, should the option not achieve its strike price on the expiry date

If you write an option, the risk involved is considerably higher than buying an option. You may be liable for margin to maintain your position and a loss may be sustained well in excess of the premium received.

By writing an option, you accept a legal obligation to purchase or sell the underlying asset if the option is exercised against you; however far the market price has moved away from the strike. If you already own the underlying asset that you have contracted to sell, your risk will be limited.

If you do not own the underlying asset the risk can be unlimited. Only experienced persons should contemplate writing uncovered options, then only after securing full detail of the applicable conditions and potential risk exposure.

Learn more about FX Options:

Forex Options – An introduction

Forex Options – Exotic options