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FX option implied volatility is currently experiencing a decline, reaching cycle lows. This trend reflects a genuine lack of realized and expected volatility within major currency pairs. Macro uncertainty appears to be contained, and the tight ranges observed in spot currency prices have led to a decrease in the cost of protection. As a result, there is now a tactical opportunity for investors to engage in cheap hedging strategies.
To illustrate this, benchmark 1-month EUR/USD implied volatility is trading at 6.5, marking its lowest level since the election victory of Donald Trump in 2024. Other expiries and major currency pairs are experiencing similar trends. Interestingly, the 1-month EUR/USD daily realized volatility is now trading at a premium compared to the implied volatility, which indicates that there could be potential value in owning 1-month options from the current levels.
A similar scenario is unfolding in the GBP/USD currency pair, where the 1-month implied volatility is recorded at 6.4, while realized volatility stands at 6.85. Additionally, overnight options are not adding much volatility risk premium in light of the recent U.S. inflation data; instead, there is more attention on the jobs data that has been released lately.
Looking ahead, the one-week expiry now incorporates the U.S. Federal Reserve rate announcement scheduled for September 17. However, the market has fully priced in a 25 basis points cut and there are no expectations for any related comments that might affect the current interest rate path. Consequently, any additional gains in 1-week expiry implied volatility have been modest at best.
In the USD/JPY market, option flows continue to indicate a demand for topside strikes that are set to expire following the leadership vote of Japan’s Liberal Democratic Party (LDP) on October 4. This suggests that traders are hedging against a potential negative outcome for the Japanese yen. Although risk reversals still exhibit a downside strike premium, they remain close to longer-term lows, indicating a lack of strong conviction for a sharp rebound in the yen's value.
On a different note, the AUD/USD pair has finally surpassed its 2025 high at 0.6625, which opens the door to further upward movement and the possibility of increased volatility. This change presents a more attractive case for AUD puts, particularly through zero-cost structures, wherein lower strikes are sold to fund the required protection against potential downturns.
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Patrick has been involved in the financial markets for well over a decade as a self-educated professional trader and money manager. Flitting between the roles of market commentator, analyst and mentor, Patrick has improved the technical skills and psychological stance of literally hundreds of traders – coaching them to become savvy market operators!