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Using FX Options IV as indicator

  • #1
  • First Post: Dec 23, 2021 6:23am Dec 23, 2021 6:23am
Here's something interesting regarding Options

Quote form investopedia:
"Implied volatility represents the expected volatility of a stock over the life of the option. As expectations change, option premiums react appropriately. Implied volatility is directly influenced by the supply and demand of the underlying options and by the market's expectation of the share price's direction. As expectations rise, or as the demand for an option increases, implied volatility will rise."

So here is the question, has anyone tried using FX Futures Options Implied Volatility as an indicator to filter which FX pairs to trade or use it in any other way?

Cheers, and happy holidays!
Know thyself
  • #2
  • Dec 23, 2021 8:49am Dec 23, 2021 8:49am
Quoting fxanalysis
Here's something interesting regarding Options Quote form investopedia: "Implied volatility represents the expected volatility of a stock over the life of the option. As expectations change, option premiums react appropriately. Implied volatility is directly influenced by the supply and demand of the underlying options and by the market's expectation of the share price's direction. As expectations rise, or as the demand for an option increases, implied volatility will rise." So here is the question, has anyone tried using FX Futures Options Implied...
Found the answers I needed..

Turns out Bank of International Settlements were also interested in this topic and did a study.
The information content of implied volatility from currency options (bis.org)

Discussion is still open, please share if you have any experience with IV in trading.
Know thyself
  • #3
  • Dec 25, 2021 6:46am Dec 25, 2021 6:46am
Here is another interesting question.

Can the changes in swap values be used as an indicator?
Know thyself
  • #4
  • Dec 25, 2021 2:09pm Dec 25, 2021 2:09pm
Quoting fxanalysis
Here's something interesting regarding Options Quote form investopedia: "Implied volatility represents the expected volatility of a stock over the life of the option. As expectations change, option premiums react appropriately. Implied volatility is directly influenced by the supply and demand of the underlying options and by the market's expectation of the share price's direction. As expectations rise, or as the demand for an option increases, implied volatility will rise." So here is the question, has anyone tried using FX Futures Options Implied...
Hi, I did that. Long story short, I tried predicting the next day and next week price change in several currency pairs, but it did not really predict anything. If it may help to you for further studying - it is usually referred as Risk Reversal and for that purpose you use the 25 delta put and call options. Basically, their difference points out the skewness of the expected market returns as percieved by option traders.

Regarding the paper you shared (based on the tables I've found there, I haven't read it), they use only implied volatility and realized volatility, which is fine, but it is likely not what you are looking for - they do not use it for predictions of future returns.
  • #5
  • Dec 26, 2021 2:26pm Dec 26, 2021 2:26pm
Quoting danos
{quote} Hi, I did that. Long story short, I tried predicting the next day and next week price change in several currency pairs, but it did not really predict anything. If it may help to you for further studying - it is usually referred as Risk Reversal and for that purpose you use the 25 delta put and call options. Basically, their difference points out the skewness of the expected market returns as percieved by option traders. Regarding the paper you shared (based on the tables I've found there, I haven't read it), they use only implied volatility...
Thanks for the input. Hadn't heard of this 25 delta method.
Initially I was wondering if IV can predict future volatility, that's it, but I'm open for anything, curious in experience people have and the ways IV can be used in.

Happy holidays!
Know thyself
  • #6
  • Dec 27, 2021 3:34am Dec 27, 2021 3:34am
Quoting fxanalysis
{quote} Thanks for the input. Hadn't heard of this 25 delta method. Initially I was wondering if IV can predict future volatility, that's it, but I'm open for anything, curious in experience people have and the ways IV can be used in. Happy holidays!
In that case, there are many papers using IV to predict realized volatility. I liked this one https://doi.org/10.1016/j.jempfin.2012.07.001. I have replicated it on crypto (BTC/USD, ETH/USD) and it worked better than simple HAR model. Are you just curious or is there a special application of yours for which you would need better RV predictions?=)
  • #7
  • Last Post: Jan 3, 2022 6:51am Jan 3, 2022 6:51am
Quoting danos
{quote} In that case, there are many papers using IV to predict realized volatility. I liked this one https://doi.org/10.1016/j.jempfin.2012.07.001. I have replicated it on crypto (BTC/USD, ETH/USD) and it worked better than simple HAR model. Are you just curious or is there a special application of yours for which you would need better RV predictions?=)
Genius work.

I studied this a long time back and couldn't better predicting vols any better than using simple historical averages but that may be my maths skills to blame.

But two things came out of it that are still useful today - firstly that - obviously - intraday vols vary massively. Not just asian session vs london/us, but particularly over key moments eg the cut, the fix etc. Secondly studying where price is against option tenors at its extremes is revealing too, in terms of tracking large scale positions
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