FX options double the risk premium for GBP/USD downside
June 18 (Reuters) -Risk reversals are an FX option strategy to capture FX volatility in a particular direction and those in GBP/USD have seen their downside over upside strike premiums double over recent sessions.
Volatility is an unknown yet key parameter of an FX option premium so dealers use implied volatility as a substitute. If realised volatility is high or expected to increase, then implied volatility will reflect that and vice versa.
Risk reversals show which FX direction is likely to generate the most volatility and charge an implied volatility for strikes in that direction versus the other, albeit the same distance from the FX spot. The benchmark 1-month expiry 25 delta risk reversal has seen its implied volatility premium for GBP puts over GBP calls, strikes below the current GBP/USD spot versus those above, double to 0.85 in the last week. This downside over upside strike implied volatility premium has increased across other expiry dates, too.
This price action reflects a market increasingly cautious about a potential drop in GBP/USD and a corresponding rise in implied and realised volatility.
The last time the 1-month expiry 25 delta GBP/USD risk reversals had such a high GBP put over call implied volatility premium was in mid-April 2024. At that time, the premium rose from 0.45 to 1.1, driven by a significant drop in GBP/USD from 1.2700 to 1.2299 following a strong U.S. CPI report on April 10, which bolstered the USD across the board.
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GBP/USD 1-month expiry 25 delta risk reversals https://tmsnrt.rs/4csuJOH
(Richard Pace is a Reuters market analyst. The views expressed are his own)
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