FX fear gauges show a greater risk of EUR/USD losses
Oct 1 (Reuters) -EUR/USD has been pinned to the 1.11's since trading at a new 13-month high above 1.1200 in late August, but the directional FX risk premium in FX option markets shows a greater risk of EUR/USD setbacks than of extended gains.
Risk reversals are options that benefit from FX volatility in a particular direction and will consequently demand a volatility risk premium for related strikes. The benchmark 1-month expiry EUR/USD 25 delta risk reversals changed from a EUR put to a EUR call premium (downside to upside strikes) on the initial EUR/USD break to 1.1201 in late August. It reached a new 4-year high at 0.3 EUR calls over puts, but struggled to retain that premium, reverting to EUR puts over calls (downside strikes).
This shows that the options market perceives a greater risk of EUR/USD trading lower and increasing FX volatility, as opposed to extending recent highs above 1.1200 to achieve the same result.
There's typically a correlation between implied volatility and the 1-month expiry risk reversal, whereby implied volatility will increase if the FX spot price moves in the direction of the risk reversals premium. In the case of EUR/USD, that's currently to its downside.
The early London EUR/USD setback to the low 1.11's endorses this correlation, with the benchmark 1-month expiry implied volatility consequently trading from 6.1 to 6.25 as the 1-month 25 delta risk reversals trade at new 6-week highs for downside over upside strikes at 0.2.
There are some huge impending FX option strike expiries which could help to keep EUR/USD in the lower 1.11's through Friday's NFP data.
For more click on FXBUZ
EUR/USD 1-month expiry FXO 25 delta risk reversal https://tmsnrt.rs/3zBKNAc
EUR/USD 1-month expiry FXO implied volatility https://tmsnrt.rs/3Y6itzo
Richard Pace is a Reuters market analyst. The views expressed are his own; Editing by Kevin Liffey
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