Wednesday, June 10, 2015

Euro – dollar implied volatility breaks to a new peak | The ‘Fear Index’ is due to two concerns

Here at OmiCronFX we are always conscious of the volatility of currency pairs. It is one of the factors that must be taken into account when we set the parameters for the Mandelbrot Algorithmic Forex trading software. The tool we use for this, for the Euro – US dollar pair, is the EVZ index, which is maintained by the Chicago Board Options Exchange, or CBOE.

This index uses the same methodology as the well-known VIX index, which the CBOE has been publishing for many years now, and which measures volatility, or to be more precise, implied volatility, for equities and equity indexes. Known in the business as the ‘Fear Index’, the VIX is compiled each week based on an analysis of the volume of options that pass through the CBOE’s option exchange. It is known as the Fear Index because heightened option activity indicates that market participants are hedging against the fear of a fall in whatever instruments they taken positions in. Each of these indexes attempts to look ahead by about 30 days to give an indication of what volatility will be like in the underlying during that time period.

The CBOE Forex implied volatility index, EVZ, has been elevated for a little while now. It has been running at well over double its value of a year ago. Recently however, it breached the highest high it has been since the middle of 2012 (see chart above).

Volatility is down to two concerns

This heightened level of implied volatility is brought to you courtesy of the twin concerns around the imminent start of interest rate rises in the US, and the Greek question in the Eurozone. One, an interest rate rise program in the US, is definitely going to happen, the only issue is when, while the other, whether or not Greece will be forced to leave the Euro, with all the turmoil that can be expected to bring, seems to be as much up in the air as ever but with a real crunch deadline, the repayment of IMF loans for which the country does not have the resources and which will not be extended, coming ever closer. It is now one minute to midnight as far as Greece, and the Single Currency, is concerned.

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