Tuesday, May 5, 2015

Volatility is important for trading | …and it is now at a high level for the Euro

The Chicago Board Option Exchange (CBOE) has long maintained an index of volatility of equities, indicating the rate at which their prices are expected to move now relative to other periods. Volatility is important for trading – if the price of a share or a commodity, or the exchange rate of a currency pair, is not rising and falling, then there will be no opportunities for those who buy and sell to turn a profit. Extreme short term bi-directional volatility can be a problem, of course, as it can lead to the repeated taking out of stop loss orders.

The VIX index is the longest established, and perhaps the best known, of the volatility indexes. For a description of it we can do no better than to reproduce here from the CBOE website:

VIX and Volatility
The CBOE Volatility Index® (VIX® Index) is considered by many to be the world's premier barometer of equity market volatility. The VIX Index is based on real-time prices of options on the S&P 500® Index (SPX) and is designed to reflect investors' consensus view of future (30-day) expected stock market volatility. The VIX Index is often referred to as the market's "fear gauge."

The same organisation has indexes for other asset classes too, and currencies are no exception. The chart at the top is the CBOE EuroCurrency volatility index, which gives us an indication of what the market is expecting for the EURUSD pair.

EVZ is now at a high level for the Euro

As can be seen from the one-year chart above, volatility in the Single Currency is at a high level at present, particularly in comparison to where it was this time last year. The waxing and waning Greek situation, Eurozone Quantitative Easing and Federal Reserve indecision about core interest rates could all be factors that contribute to this.

The index often exhibits a seasonal quality and can fall in the Summer months – a reflection, perhaps, of the old adage that says stock traders “Sell in May and go away”. There is no sign of that yet this year, but perhaps it is early days. 

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