FxWirePro: Low Vols Regime Persists In G10 FX-Bloc Despite Geopolitical Risks

We had all been pleased that with the prospect of a phase 1 agreement between the US and China uncertainty on the markets would fall and that times would become less hectic, and then the US President Donald Trump takes everyone by surprise right at the start of the New Year by creating a new flash point - this time round in the Middle East. The market reaction was pretty pronounced accordingly and the dollar appreciated due to its role as a safe haven in uncertain geopolitical times, although after the initial panic things seem to have settled down again. Since no further bad news from the Middle East followed, markets have calmed down somewhat and panic moves like in the USD or the JPY have been corrected.

It can nonetheless be assumed that the US President is unlikely to become any more conciliatory this year and instead will cause new flash points or re-open existing ones (e.g. the trade conflict with China) during the election year in an effort to attract votes. 

As a result, it remains vital to keep an eye on his twitter account. However, he is unlikely to overdo it though as he will not want to significantly affect the performance of the US stock markets.

What does that mean for the FX markets? The historically low volatility is unlikely to rise notably in the near terms, but, as was the case last year, we are likely to see an intermittent rise in risk aversion which will lead to the typical reflexes amongst traders: depending on the flash point the corresponding safe havens will appreciate, with high beta and EM currencies easing. EURUSD’s low IVs also persist despite the above geopolitical tensions, the pair pops up low IVs at 4.6% for 1w tenors which is the least among G10 FX-Bloc.

Hence, contemplating above factors, initiated write an (1%) out of the money put option of 2w tenors, and add long in 2 lots of EURUSD at the money -0.49 delta put options of 3M tenors, (spot reference: 1.1183 level). Short-legs go worthless as the underlying spot price hasn’t gone anywhere. Any slumps from here onwards are to be arrested by the 2 lots of ATM long-legs. Courtesy: Commerzbank