Value capture in forex options: When implied volatility approaches actual volatility, the premium cost is relatively low
- Foreign exchange options rely on volatility and rapid directional movements, but these two key elements have been largely absent in the forex market recently. Implied volatilities across various maturities are generally at low levels, making the payment of option premiums seemingly a losing game.
- Take AUD/USD as an example: in mid-May, the one-month implied volatility was 7.7, while the realized volatility over the past month was 7.5, almost enough to support the implied level. If spot continues its recent pattern, holders can almost cover their premiums, and this narrow gap provides real value.
- When AUD/USD dropped sharply, realized volatility spiked and pushed implied volatility from 7.7 up to 8.8. In this scenario, option holders not only benefited from the directional movement, but also profited from the volatility expansion itself. Subsequently, both fell back to 7.7, returning to the starting point.
- In a low-volatility environment, the threshold for profit may be lower than it appears. When implied volatility approaches realized volatility, the cost of options is relatively low, and even a modest rebound in spot prices can put holders into a profitable position.
Disclaimer: The content of this article solely reflects the author's opinion and does not represent the platform in any capacity. This article is not intended to serve as a reference for making investment decisions.
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