A sharp drop in forex market volatility expectations has coincided with pullbacks in the safe-haven US Dollar, and a continued slide in vols could produce further USD weakness. FX Options risk reversals have likewise broadly shifted in favor of Greenback weakness. This is especially the case against the British Pound and Swiss Franc where options traders are at their most USD-bearish in at least the past quarter. Though the risk of short-term corrections grows as the USD falls further, current sentiment readings favor continued US Dollar weakness.
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Euro/US Dollar Options Analysis
Sharp Euro rallies against the US Dollar have been met with similarly aggressive shifts in FX Options market risk reversals. Our benchmark breakout-style trading system theoretically went long the pair as of June 11 as the 1-week risk reversal hit its highest highs of the previous 90 days. Suffice it to say that trade has theoretically worked out quite well, As it stands, risk reversals clearly favor further gains yet the risk of short-term corrections is high. We will subsequently look to buy dips on the resurgent EURUSD pair.
British Pound/US Dollar Options Analysis
Continued surges in the British Pound have been met with similarly aggressive moves in FX Options Risk Reversals, and our benchmark breakout-style system hypothetically went long the pair as of June 14. Said system has hypothetically done very well with the British Pound in recent history, and two weeks ago we wrote that we remained bullish the pair until further notice. As we wrote previously, the risk of short-term corrections grows as the pair appreciates further. Yet outlook remains bullish on the clear shift towards bets on/hedges against British Pound strength against the USD.
US Dollar/Japanese Yen Options Analysis
Forex options market sentiment has been very inconsistent on the US Dollar/Japanese Yen pair. Sharply choppy price action has led to similarly sharp swings in risk reversals, and such indecision gives few clues on what to expect next out of the USDJPY. Forex Futures markets show that Non-Commercial traders—most often speculative in nature—remain quite heavily net-short the US Dollar against the Japanese Yen. If nothing else, the risk of short covering gives us a very modestly bullish bias. Yet we would hardly place aggressive trades on any such hunches.
US Dollar/Canadian Dollar Options Analysis
Forex options market sentiment has seen a sharp shift towards betting on and hedging against US Dollar weakness against the Canadian Dollar (USDCAD losses), leaving short-term momentum firmly in the Canadian Dollar’s favor. Forex Futures positioning, on the other hand, is at its least bearish the USDCAD since it traded closer to the C$1.10 mark—leaving plenty of room for a buildup in USDCAD short positions. Our breakout-style risk reversals system will wait until risk reversals drop further, but a continuation of the current downmove in the USDCAD makes selling rallies a reasonably attractive proposition.
US Dollar/Swiss Franc Options Analysis
Dramatic Swiss Franc advances (USDCHF declines) have left FX Options risk reversals plainly in favor of further USDCHF losses. Our benchmark breakout-style FX Options risk reversals system would have gone short the USDCHF as the 1-week 25-Delta Risk Reversal hit its lowest levels in the previous 90 days on June 14. Dramatic weakness leaves clear risk of short-term corrections, but it seems that the tide has turned in favor of continued CHF appreciation (USDCHF declines).
Australian Dollar/US Dollar Options Analysis
Our short-term bias for the Australian Dollar/US Dollar pair is unclear as mixed sentiment and intensely choppy price action makes it difficult to establish any short of conviction in short-term forecasts. Just several weeks ago we had called for declines amidst a sharp shift towards bets on and hedges against further Australian Dollar weakness. Yet a dramatic turnaround in the AUDUSD has pushed risk reversals significantly higher. If anything, the sharp shift towards bets on/hedges against AUDUSD strength leaves us in favor of short-term rallies. Yet we hesitate to switch direction after having previously called for aggressive declines.
New Zealand Dollar/US Dollar Options Analysis
Extremely choppy price action in the New Zealand Dollar/US Dollar pair is making short-term forecasts especially difficult. Two weeks ago we wrote that a substantive shift towards bets on/hedges against NZDUSD weakness signaled further declines were likely. More recently those same risk reversals have bounced considerably from their lows. Given such market indecision, we will remain in “wait and see” mode on the NZD until further notice.
Written by David Rodríguez, Quantitative Strategist for DailyFX.com, drodriguez@dailyfx.com
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