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Euro and British Pound Price Action May Slow, but Watch out for the Yen

Wednesday, 16 January 2008 20:53:59 GMT

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Written by David Rodriguez, Currency Analyst

Implied volatility is one of the most tried and true methods for objectively measuring expected volatility in the spot market.  Derived from currency options with different maturities, implied volatilities are used to help predict potential movements in the spot market and is one of the most popular strategies of systems traders and other professional hedge funds.

At its most fundamental, the basic and intuitive interpretation of this implied data is often the most telling for traders.  Taken alone, a steady rise in the longer-term implied volatility (the red line) is indicative of a strengthening trend; while inversely, a decline often reveals that a period of range or consolidation in spot is ahead or already in place.  Additionally, the histogram or spread between the shorter and longer-term implied volatilities (the blue colored bars) tells a different perspective. As the histogram rises, volatility is expected to pick up faster in the near future relative to the longer-term range.  Ultimately, this increases the probability of a breakout scenario in the underlying currency.

 

range trader 01-16-08a  

EURUSD

 

Recent Euro volatility has occurred within a backdrop of gradually rising implied volatilities across virtually all expiries, but it is interesting to note that our implieds spread has actually remained relatively unchanged for four weeks in a row. Such relatively muted two-week vols suggest that traders do not expect particularly extreme price action through short-term trading within the context of the overall trend.  As such, we will claim that the Euro will continue to range in the week ahead. Yet very elevated longer-dated volatilities suggests that the strong trend will continue on a more medium term basis.

 SPOT PRICE         READING
 1.4659                Range
 LAST WEEK'S SPREAD
  0.18
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

 

range trader 01-16-08b  

GBPUSD

 

The volatility outlook for the GBPUSD is unsurprisingly similar to that of the EURUSD, with the same rise in longer-term implied volatilities occurring with comparative stability in shorter-dated vols. Such a muted spread between shorter and longer-dated expirations suggests that traders do not expect especially strong volatility through short-term trading. Yet the stronger longer-term trend will persist once short-term begins rising above longer-dated—leaving our previous trending bias fairly intact.

 SPOT PRICE         READING
  1.9626               Range
 LAST WEEK'S SPREAD
  0.15
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

 

range trader 01-16-08c  

 

USDJPY

 

Japanese Yen volatility is always very difficult to predict, as price tends to break out of previous ranges with relatively little warning. That said, the surge in vols across the spectrum suggests that traders fully expect further choppy price action through the medium term, but it is nonetheless interesting to note that shorter-term vols have sharply lagged against their longer-dated counterparts. Such a strongly negative volatility spread would typically suggest that price action will slow through short-term trade. Of course, we must put this into the context of 3-month vols at a whopping 14.85 percent. On balance, we expect moderate volatility.

SPOT PRICE         READING
 107.52               Moderate Volatility
 LAST WEEK'S SPREAD
  0.60

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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