Investors are not only interested in market direction. The speed of the change, or volatility, is also important. It is critical for appreciating and managing risk. The volatility we look at here is implied, or embedded, in current option prices. This is different than historical volatility, which is the actual volatility of the underlying.
What the accompanying chart shows is that over the past six months, the implied volatility of the yen is fairly flat, but considerably higher than a year ago. Implied volatility has been trending down since late June when it hit 16%, but since the third week of July volatility has traded broadly sideways and tested the 20-day average (~12.4) earlier today. In the current environment, a weaker dollar, through JPY96 and possibly to retest the mid-June low near JPY94, implied volatility is likely to rise.
Of the selected currencies we look at here, the Australian dollar has seen the biggest rise in implied volatility over the past six months. As the Aussie has been squeezed higher this week, implied volatility has eased. We would expect this to continue during what appears to be a corrective phase. There is scope for implied volume to decline toward 10.0.
The implied euro volatility has trended lower. The recent gains in the euro have coincided with a decline in implied volatility. If the euro gets much above $1.3400, the upper end of the 6-month trading range, implied volatility may rise on ideas that this represents a break out.
Sterling and the Canadian dollar implied volatility is practically unchanged from a year ago. Both currencies are lower in the spot market (1.0% and 4.4% respectively). In the past week, sterling has rallied more than 4 cents, but implied volatility has fallen. It finished last week near 8.4.and now stands at three month lows. If sterling were to break above $1.56, implied volume may rise as a breakout is threatened.
The Canadian dollar has the lowest implied volatility in the G10 currencies, just above 7%. For the better part of the past 2.5 years, the US dollar has traded largely in a CAD0.9600-CAD1.05 range. Once it became clear in mid-July that despite the firmness of the US dollar, there was not going to be a breakout, implied volatility fell. There is scope for implied volume to decline toward 6.5% in the coming weeks.
Three Month Implied Volatility