Pronounced choppiness in major forex pairs and broader financial markets has led to similarly dramatic shifts in FX Options sentiment, making short-term currency moves especially difficult to forecast. A benchmark FX Options risk reversals strategy called for going short EURUSD, GBPUSD, USDJPY, AUDUSD, and NZDUSD through last week’s trade—leading to significant drawdowns as markets quickly retraced earlier moves. Our DailyFX volatility indices remain near their highest levels in over a year, and we urge caution against excessive leverage through such choppy market conditions
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Continued Euro depreciation against the US Dollar leave FX Options risk reversals at bearish extremes, underlining risk of further EURUSD declines. In the past several years, buying the EURUSD when the 3-month FX Options Risk Reversal percentile hit 0 percent has worked reasonably well. Whether or not such a contrarian strategy works through the near term is far less clear, however; it seems that both FX Options and Futures positioning plainly favors further EURUSD losses. We remain cautiously bearish, but now is perhaps not the time to establish fresh short positions on risk of retracement.
Similarly dramatic declines in the British Pound/US Dollar pair have pushed FX Options risk reversals to bearish extremes. Three-month risk reversals continue near their most negative since the GBPUSD set decade lows in late 2008, and elevated volatility expectations leave scope for further declines. Our benchmark breakout-style risk reversal system called for a short position through last week’s tumbles.
Forex futures positioning and options market sentiment on the US Dollar/Japanese Yen pair are currently at opposite extremes, making short-term forecasts especially difficult on the highly choppy pair. Last week we wrote that fresh lows in FX Options Risk Reversal percentiles called for USDJPY short positions, but markets clearly had other things in mind in sending the USDJPY sharply higher through subsequent trade. Our short-term bias is effectively neutral. Options point in one direction and futures in another, leaving markets indecisive and price action especially difficult to anticipate.
advances led to similarly pronounced moves in FX Options market sentiment, leading us to believe that the pair could continue higher through recent trade. Yet extremely choppy price action has effectively left the Canadian Dollar unchanged against the US Dollar—making our proposed trading position unprofitable in the process. We maintain a bullish medium-term bias on the USDCAD as positioning recovers from recent bearish extremes, but incredible volatility makes shorter-term outlook decidedly less clear.
US Dollar sentiment against the Swiss Franc has improved considerably as of late, with longer-dated options putting a significant premium on out-of-the-money USDCHF
calls. Combined with fairly net-long CFTC Non-Commercials futures positioning and general USDCHF strength, there is scope for further short-to-medium-term strength.
We have been caught on the wrong side of the AUD/USD
trade an embarrassing number of times now, but the recent tumble gives reason to expect further declines in the high-flying currency pair. Heavily net-long Non-Commercial leaves the Australian Dollar in an overbought position, and the dramatic shift towards out of the money puts gives reason to remain bearish until further notice. Indeed, our benchmark breakout-style trading system called for an AUDUSD short on May 5 and we are accordingly bearish.
Our short-term trading stance on the New Zealand Dollar/US Dollar currency pair is quite similar to that of the AUD/USD. Overbought Non-Commercial futures positioning leaves the New Zealand Dollar at particular risk of declines as traders unwind their leveraged positions. Our breakout-style risk reversal strategy called for a short on May 5 and we remain bearish accordingly.