From the April 2014 issue of Futures Magazine • Subscribe!

Currency volatility trading

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Ratio analysis of three currency pairs is shown on “Forex ratios” (below). They are euro-to-Swiss franc, euro-to-Australian dollar, and British pound-to-Canadian dollar. The virtually horizontal line at just above a ratio of 1.20 represents the commitment of the Swiss National Bank to defend its currency. The Australia and Canada central banks held on until April and May of 2013. At that point, Australia and Canada opted to weaken their currencies internationally and Great Britain hinted at a tighter monetary policy

The concise nature of the forex ratios extending two years for the franc and almost a year and a half for the Australian and Canadian dollars is evidence that they really had little independent volatility during those time periods other than short-term variations around the more stable member of the pair. “Forex calls: November 2011” suggests that the volatility relationships were recognized by the options market. The Canadian dollar call option price curve is slightly higher (more volatile) than the British pound, and the Swiss franc and Australian dollar price curves are higher than the euro. Thus, the structure of forex call prices in November 2011 made a reasonably good forecast for the following two years.  

A similar forecast is shown on “Forex calls: January 2014.” The volatility structure reflects the currency relationships extending from 2012 and 2013. At the bottom of the chart with the lowest projected volatility is the British pound with a curve height of 1.71% (call price-to-strike price). The pound’s trading partner, the Canadian dollar, is slightly more volatile at 1.81%.

Currencies connected to the euro are also placed to continue their relative price movements. The euro call curve height, 1.74%, is topped by the Swiss franc at 2.25% and Australian dollar at 2.37%. The yen, at 2.56% exceeds the other currencies’ implied volatilities, and as mentioned earlier, the forecast of high volatility for the yen may result in overvaluation of related futures and options.

In a world of shifting economies, interest rates, and currency values, forex traders should look to central bank strategies in determining the direction and timing of trades. The volatility structure assists in the forecast of currency futures price trends.

Also, read, Top 10 reasons to trade FX.

Paul Cretien is an investment analyst and financial case writer. His e-mail is PaulDCretien@aol.com.

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