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Selling the FX fear premium might pay dividends

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June 18 (Reuters) -FX option prices were boosted by FX volatility risk premiums attached to the impending French elections and are looking rather enticing from a short volatility perspective.

High FX realised volatility, or expectations of an increase, can drive implied volatility higher. Implied volatility is a substitute for that unknown quantity of FX realised volatility when pricing an option, and in the case of regular vanilla options, higher implied volatility increases the premium. FX options can therefore be monetized by buying and selling contracts as their implied volatility and/or realised volatility expectations change.

The uncertainty and threat to the EUR from the French elections has driven implied volatility and vanilla option costs significantly higher, especially those that allow holders to sell EUR. But actual/realised volatility will have to increase significantly to outperform current implied levels.

The benchmark 1-month expiry EUR/USD implied volatility has gained 3.0 in the past week to 8.0 - a significant short term increase. Historic volatility is past realised volatility and often used as a fair-value gauge. One-month EUR/USD historic volatility has risen to 5.85 - significantly lagging implied volatility.

Those who think FX can maintain familiar ranges and not over-react to the eventual French election results could benefit from short volatility strategies in related currency pairs.

For more click on FXBUZ

EUR/USD 1-month expiry implied vs 1-month daily historic volatility https://tmsnrt.rs/3zaQBjC

(Richard Pace is a Reuters market analyst. The views expressed are his own)


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