Did the FX Smile just smile at me?

Importer / Exporter - Did you know that the “Smile” is smiling at you these days?

The parameter that most influences the option price for a given time is the standard deviation, also known as volatility.

The higher the volatility, the higher the option price. If we buy an option when the volatility is high - we will pay a high premium for it. If we sell it, we will receive a high premium.

And the opposite is also true.

Dec 1, 2020

These days, standard deviations are relatively low, certainly compared to standard deviations a month ago.

At a time when the standard deviation is low, hedging companies tend to fall asleep. Complacency? Hello !!! Wake up and smell the falafel.

Nowadays is the shopping season, Black Friday, Cyber ​​Monday, and all the various shopping holidays. So go shopping for currency derivatives. Or at least check quotes.

Where can you see that the standard deviation is low?

The chart below shows a standard deviation for a period of six months in major currency pairs.

• The orange line describes the standard deviations a month ago.

• The green line describes the standard deviations a week ago.

• The blue line describes the current standard deviations.

A simple look shows that the standard deviations are currently lower than a month ago, and slightly higher than a week ago.

If you want to delve deeper into graphs (and you not really have to), then it is important to understand that there is a different standard deviation for each strike rate.

The X-axis depicts the Delta, with Delta 0.5 is the center which is also the Forward rate for the period. To the right of it, here are higher rates - the Call Options area. To the left of it, there are low rates - the Put Options area.

We will not now go into the explanation of what Delta is. The truth is I only remember the formula when I have a good hair day. And anyone who knows me knows that I bald.

But I deviated from the subject ...

• If you see in the graph that the surfer waves from the left to the right, it means that the Put is more expensive compared to Call, at the same relative distance from the forward rate.

• If you see kayaking sailing from right to left, that means Call is more expensive compared to Put, at the same relative distance from the forward rate.

• If you see a surfer walking horizontally, it means he is looking for waves. And also because the Smile is balanced and the Put prices are about the same as the Call, at the same relative distance from the forward rate.

In conclusion:

• Time to check quotes and go shopping!

• It is advisable to have a currency derivative calculator beforehand to plan the hedging operations. I'm not sure the dealer would be happy to give you prices of all sorts of strategies (they have no patience for this, are they?)

• If you do not have a calculator, then you should check out our 👉 calculator. If you're already here ...

And a short message to companies that only use forward:

• If you are going to continue to execute forwards only, then I may have to apologize if you wasted your time reading this article. This is because the standard deviation does not affect the forward rate. If you check the 👉  forward formula, you will not find a standard deviation there.

• If you are thinking of starting to learn how to hedge using options as well, then you have come to the right place. There is no one suit (forward) that can really fit everyone. Start by reading the blog. The book will arrive soon. Take the calculator for a trial and have the feel for it, and learn how the thing works.

Disclaimer:

This post does not constitute advice or recommendation.

Anyone who uses the information presented here does so at his own risk.

‘Calc fellow’ is not a consulting firm and does not provide a source of liquidity for derivative transactions.

‘Calc fellow’ provides tools to companies to help them manage their currency risks (Software as a service). We provide a derivative pricing calculator. We also provide policy tracker and FX derivatives inventory management tools.