COMMENT: Are FX options underpricing U.S. PCE data risk?
July 26 (Reuters) -U.S. PCE data is the U.S. Federal Reserve's preferred inflation data and Friday sees the last release before next Wednesday's policy decision, but it doesn't appear to have attracted much in the way of additional FX volatility risk premium from the FX options market.
FX volatility is an unknown, yet key parameter of an FX option premium so implied volatility acts as a stand-in. Any disparity between implied and actual volatility therefore creates trading opportunities. However, implied volatility changes before key data and events are also a bellwether for the perceived FX reaction, especially those included within short duration overnight expiries options (next working day at 10-am New York).
Implied volatility is always lower on a Friday to account for the two lost trading days before a Monday expiry, but the premium/break-evens will remain consistent and offer a clearer picture for any Friday data.
Using a simple vanilla straddle option as an example - overnight expiry EUR/USD option premium/break-even is just 26 USD pips in either direction, unchanged from its long-term average since including the PCE data.
AUD/USD overnight expiry premium/break-even is 32 USD pips in either direction, having been around 30 USD pips this week and comparable with a recent average of 28 USD pips in either direction.
USD/JPY is the most sensitive to risk and yields and should outperform on any data-related FX reactions. However, shorter-dated FX option implied volatility/premiums posted big gains amid the recent JPY surge and overnight expiry was no exception, so it's harder to gauge any additional PCE-related premium while these options remain elevated.
The current premium/break-even for an overnight expiry USD/JPY vanilla straddle is 113 JPY pips in either direction and compares with 115 pips over the last couple of sessions and an average around 90 JPY pips prior.
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Overnight expiry FXO implied volatility https://tmsnrt.rs/4dhbXKH
(Richard Pace is a Reuters market analyst. The views expressed are his own)
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