Forex Implied Volatility

Just to get a better understanding.
Is the Implied Volatility of any considerable significance, especially in predicting Forex trends (both short and medium term). How does one read the volatilty numbers?

 

estrader,

I’m just curious -- where have you seen implied volatility numbers for forex?



“How does one read the Implied Volatility number?”
Please note -- I’m not entirely sure but this is what I believe:

If the I.V. number is 10%,
and it is the I.V. for one year (which is the normal time interval),
and let’s say the current stock price is 100.00,
Then the 10% signifies the first standard deviation prices (90.00 and 110.00 -- which are 10% away from the current price). So this means that during the next one year’s time there is a 68% chance that the price remain within the 90.00 to 110.00 price range. (The 'first standard deviation' implies the 68% probability here.) Or there is about a 32% (i.e. 100% - 68%) chance that the price will move outside of this range within one year’s time. (However these are rough estimates and I ignored ideas like “risk free interest“.)



Usually I.V. is used for options trading. If the trader thinks that a specific option’s I.V. is too high, then he is also assuming that the option’s price is too high -- and so he might consider selling it. Or if the option’s I.V. and price is lower than what he estimates then he may consider buying it.

I’m not sure how helpful I.V. is for predicting trends , but if the option’s calls have a significantly higher I.V. than the corresponding puts, then maybe people are expecting the price to go up (or maybe people are just hedging against there short position)???

Anyway, people in the “Options Forum” may know more about this I.V. stuff -- so you might want to ask some questions in there…

 

Thanks for detailed reply.
I see Options I.V. in Refcos' FX news feed, options section (I guess FX options). See the attached file. I was just wondering if you can draw some useful info from these, or basic MACD and EMA is enough for tech analysis.

 

Thanks for the source and attachment. It seems like the info might be good for something -- but I really don't know... I'd guess most people mostly go off just the price charts for the technical analysis stuff. (???)

 

In case anybody is searching through old posts (like I was earlier today) to find details about how to use implied volatility and the futures/options market as a tool in spot forex, you will be interested in checking out this article:

http://www.investopedia.com/articles/optioninvestor/05/022305.asp

It does explain a bit about the FXCM implied volatility news update also.


Does anybody take implied volatility into consideration?? I'm just starting to think through how it could influence the models that I want to build. However, they are just early thoughts in my head right now...

 

You want to not only look at the implied vols for the pairs but the risk reversals as well.

Here is how the implied vols work, it is a theoritical volatility you have to plug into the model to get the options price to equal what you are seeing in the market. Options are priced by volatility because all other aspects of it (expiry, strike price, price of underlying, risk free rate) are fixed. The more volatility, the more valuable an option is, which is why the further you go out the more vol is included in the model. Most of these are based off a Black-Scholes type of model (well for currencies its Garman-Kolhagen based). You can use the Vols to know wheter a currency is range bound or trending as well.

With risk-reverals it is telling you the direction that traders have priced into the market based on the price of the options. If you have a call with a a strike 100 pips above the market, and a put with a strike 100 pips below the market you would expect them to have the same price (well the distribution is log-normal so the call would slightly more valuable anyway but lets ignore that for now). Rarely will they. The risk-reversals show the size and direction of the bias that traders anticipate. They only work for extremes (+/- 1.5 sd) or more.

Trader/God

 

Thanks very much for the reply. It has given me many ideas for further research!

 

I think the issue with forex is that the market is fragmented. Spot forex, futures etc.

For other markets, exchange traded and "single" markets (e.g. crude oil), one can watch e.g. COT and just miss any OTC action, which might be small in some markets so no harm done.

But in forex there is Ivol/RR, COT, FXCM SSI, Oanda'a stats, which all track some part of the activity.

Maybe some seasoned forex traders can share which are the most representative, if any.

 

The institutional services publish risk-reversal and volatility cones[w,m,q,y] as standard practice.

 

I think an actual example on EURO for the next week would be quite instructive!

anyone?