Currency Options Seem Very Cheap

Discussion in 'Options' started by tommo, Feb 18, 2011.

  1. tommo



    This is just an observation and I was hoping a more experienced person may explain why. But OTM options in the currency market are significantly cheaper than the equivilent option in the equity futures market.

    So for example an option 1 st dv OTM based on a 21 period moving average of historical volatility in the S&P, (expiration 1 month), has a decent amount of value, especially on the put side.

    Looking at the equivilent on EURUSD and the option is worthless. You have to go significantly closer to the current market price to see any current value.

    I cant imagine we are just in a particularly low period of implied volatility on the EURO with the peripheral debt situation etc
  2. look at $EVZ - multi-month low

    P.S. Absolutely perfect time to buy straddles/strangles

  3. ...not sure it's particularly useful to compare such things this way given the differences in markets and conventions. It can be deceptively 'cheap/rich' imo.
  4. What specific strikes and expiries are you using? Generally, the attached shows the 3m ATM vols for the ccy and the Spooz.
  5. Markets such as S&P that are asymmetric, with many natural longs, few natural shorts -- often have one-sided skews. There's more demand for protection on one side.

    Markets such as forex are symmetric -- the dollar might crash... but the euro might also. So the options reflect this.

    Nassim has a nice discussion of the subject in his first book, "Dynamic Hedging."
  6. Muchas gracias senor.:)

    Separately, and what I was also trying to get at, is the method in which he's making the comparison would not take this into account...

    So, based on what he's saying, if he's comparing 1 Std. Dev OTM options based on X-period historical volatility - he's undoubtedly going to see 'cheap' FX options (especially on the put side, as mentioned). I guess the gripe is with the method of comparison, right?

    Point being, it's not actually cheap (maybe), given the expected returns distribution.
  7. Yes, that's a good summary. He's "discovered" the equity put skew. Woo hoo!
  8. tommo


    Not really. I was saying that equity index options are generally more expensive on the put AND call side than FX. More so the put side.

    good point about the fx market being more symmetric though.

    Just seems strange that an average 4 week move in an index option leaves you at a price with a lot of intrinsic value left (both put and call). Whereas if an average monthly move in EUR/USD is 500 ticks for example and you go 500 ticks out from the current price these puts and calls are worthless.
  9. As you can see from the scrshot, it's generally true that FX ATM vol is lower than Spooz ATM vol. There's a whole variety of reasons for why that's the case. The shape of the smile is a secondary consideration, as you say.
  10. tommo


    Excuse my ignorance but how would you interpret that data? Is that suggesting the spooz has less chance of being at the current price in x periods than eurusd?
    In my experience equity indexes seem to be far more mean reverting than a currency market
    #10     Feb 19, 2011