Euro-Dollar Volatility Tumbles Ahead of Brexit Vote: Analysis
Implied volatility in euro-dollar options shows dwindling expectations for large near-term price swings in the currency pair as both the European Central Bank and the Federal Reserve are seen holding rates this month, and as the U.K.’s June referendum on EU membership approaches, Bloomberg strategist Vassilis Karamanis writes.
One-month implied volatility dropped to 8.11 percent on Tuesday, the lowest since Dec. 2014.
Option structures are slightly overpriced on the one-month tenor, as suggested by the spread between implied and realized volatility, signaling a further drop is possible.
The euro’s volatility term structure versus the greenback is largely non-inverted and picks up over a three-month horizon. It may flatten in the front-end after markets price out this week’s ECB decision, wherein rates are expected to be unchanged, as the Fed is also expected to hold policy on April 27.
Two traders in London, who asked not to be named as they are not authorized to speak publicly, say the common currency may remain range-bound this week versus the dollar amid low expectations for President Mario Draghi to surprise investors.
Recent comments from ECB officials signal there is no sense of urgency for increased stimulus. Meanwhile, medium-term inflation expectations have held above the record low seen at the end of February.
A potential U.K. exit from the European Union remains the biggest risk for the euro. As a result, traders seem to refrain from adding large exposure ahead of the event. The spread between three-month and one-month implied volatilities is at 1.84 percent, lingering near an all-time-high of 2.1 percent seen on Friday.
The probability of a larger move in euro-dollar in a month’s time, as measured by the 10-delta butterfly, is near a two-month low. The gauge is currently at 0.60 percentage points, compared with 0.5675 percentage points on April 4, the lowest level since Feb. 2.
Note: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice