By Forex Fraud:

Forex options can be exceptionally useful for a forex trader, but there’s no single way of using them in trading. You can use them as a kind of hedging mechanism, or to reduce the overall exposure of your account to a currency pair. You may use them to limit your downside. And you may use them for purposes unrelated to trading itself, as indicators of market sentiment and positioning, for completing the spot market data depicted by the forex trading software. But whatever you do with them, you’ll eventually find that implied volatility is one of the most important concepts that you should be knowledgeable about in order to make use of options.

Options pricing is a complex subject, and requires a degree of familiarity with derivatives, and calculus in general. But there is one simple fact about options that is easily understood and useful for trader’s purposes: it is that of all the items that contribute to the establishment of an option’s price according to the most common and popular models, implied volatility is the only one that is a prediction. All the other factors, such as the strike price, interest rates, and the term of the option are well-known at the moment the contract is written, but volatility is not, and that is why it is so important in any options pricing strategy.

IV (as implied volatility is often termed by market practitioners), is simply the estimate inherent in a option contract about the future volatility of the underlying. Let’s assume, for example, that there are two option contracts with exactly the same expiry data, and payout, but very different prices: the justification for this divergence is to be sought in volatility. Simply stated, a higher volatility will result in a higher likelihood of the strike price being hit, and will as such command a higher premium. If a trader expects volatility to be higher, he’ll be willing to pay the higher premium, and vice versa.

Implied volatility is an exceptionally important subject in options analysis, but it is also relevant for forex traders as well. Rising implied volatility over a theoretical continuation of the historic volatility, for instance, suggest that options traders are on the whole convinced that the market may keep driving the trend higher. Conversely, falling volatility may imply that a period of consolidation in a currency pair may ensue, possibly preceding a reversal.

Volatility is examined and studied by traders for a wide variety of strategies, and also for hedging purposes. The volatility smile, delta hedging, convexity, are some of the concepts that are intimately related to volatility, and can be exploited by forex traders for spot trading purposes.

So get your forex demo account, and try to test some of the assumptions of the options market in trading. Soon you too will have your own toolbox of great strategies based on the dynamics of the vast options market.

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By Interactive Brokers  -

The euro is back to unchanged against the greenback at $1.4355 in early U.S. trading after earlier reaching $1.4405 following an encouraging reading of business and investor confidence. However, the dollar is not giving in so easily this morning, for now at least, and appears to be fighting its way back to erase losses against other majors. In all the dollar has had a very positive week with more investors having been forced to quit short dollar plays during a week of concerns over rising risk aversion thanks to sovereign downgrades and potential vilification for a sea change to the direction of longer term yields.

Euro – The Munich-based IFO released its strongest record of business confidence amongst German executives in 17 months. The November reading of 94.7 not only improved on October’s 93.9 index value but also surpassed expectations. The IFO cited improvements in current conditions and healthy prospects for the future based upon evidence of rising manufacturing exports, namely to China.

The IFO survey helps drag up the prospects for the Eurozone where a recent slide in confidence amongst investors this week raised question marks over the potential for the economy to maintain its momentum in the face of a stiff wind from the rising euro. As welcome as today’s latest reading on the economy is, investors are not translating that into a significant relief rally for the euro. The euro did make gains against a broadly weaker yen to ¥129.65.

U.S. dollar – The dollar faces an empty data slate on Friday and there is little to drive it heading into the weekend. With a claw back against eth euro and a rise against the yen, the dollar index is indicating a minor gain for the session.

Aussie dollar is attracting some buyers at the end of a torrid week. The mix of increasing risk aversion and a less hawkish tone from the RBA likely means that monetary policy isn’t going much higher. Still investors are clearly saying today that the potential for the currency remains bright and are buying against the dollar today at 88.86 U.S. cents.

Japanese yen –The bank of Japan announced no change to its monetary policy stance overnight and left interest rates at 0.1%. It did, however, warn that it won’t tolerate price declines. The market reaction was to sell the yen and today the dollar buys ¥90.45 and it does provoke one of those questions often investors try to understand. If the premise of interest rates remaining low caused the yen to fall today, why does it rise when financial markets recoil? At such points of inflexion when risk events create safe haven demand, it is true that the yen and the dollar both go higher as investors rank their role as safety plays rather highly. Today’s largely worthless words warning about intolerance to deflation will likely spur the notion that the government’s bond purchase program will maintain even less appealing yields on 10-year bonds.

British pound – Sterling jumped against the dollar following data released by the Bank of England showing mortgage approvals rose in volume from 60,000 in October to 63,000 last month. Earlier in the week a RICS report apparently showed a bullish take for British home prices. Together these pieces of data continue to show a resumption of possible growth. Recently a spurt in inflationary pressures implies more of the same. The pound rose to $1.6173 but the euro rose to buy slightly more pounds today at 88.66 pence.

Canadian dollar – The Canadian dollar today buys 93.85 U.S. cents as investors attempt to find a floor for Canada after yesterday’s broad U.S. dollar rally. A strong rise in domestic inflation showed up to reveal the biggest consumer price rise in a eight months. However, the jump in energy prices – 14% for gasoline prices – is due to the run off of a sharp drop in prices through October last year. So the comparison to a low November 2008 base “embarrasses” the Canadian situation. Still, Bank of Canada governor, Mark Carney reiterated his commitment to frozen rates through the first half of next year.

British Pound Outlook is Shaky Ahead of UK Q3 GDP, BOE Meeting Minutes

By Daily FX -

The British pound may face the most event risk compared to the rest of the majors, as the minutes from the Bank of England’s October meeting along with Q3 GDP results for the UK have the impact to stoke heavy volatility in the currency.

The British pound may face the most event risk compared to the rest of the majors, as the minutes from the Bank of England’s October meeting along with Q3 GDP results for the UK have the impact to stoke heavy volatility in the currency. Not to be forgotten, though, the Bank of Canada will announce their latest rate decision while the US will see a few housing-related indicators. 

•    US Housing Starts, Building Permits (SEP) – October 20, 8:30 ET
US housing starts and building permits are projected to have risen for the second straight month in September to 10-month highs, with starts anticipated to hit 610,000 from 598,000 while permits may rise to 590,000 from 580,000. While the unemployment rate is still in the process of rising, the federal government’s tax credit for first-time home buyers of up to $8,000 is likely to remain supportive of demand through the end of the year. However, if the program expires as planned on December 1, the growth we’ve started to see in the housing sector could start to wane.

•    Bank of Canada Rate Decision – October 20, 9:00 ET
The Canadian dollar could see a pickup in volatility on Thursday at 9:00 ET as the Bank of Canada is expected to leave rates unchanged at 0.25 percent once again. After the Bank left rates unchanged on September 10, they said that they would maintain a neutral stance through June 2010, and the rest of the statement was relatively optimistic as the Bank said “GDP growth in the second half of 2009 could be stronger than…projected in July.” However, they also indicated that the Canadian dollar’s strength remained a threat to not only growth, but the return of inflation back to target. Overall, indications that the Bank still sees downside risks for inflation could weigh on the Canadian dollar, but as we’ve seen in the past, the currency is more responsive to changes in the economic outlook.

•    Bank of England Meeting Minutes – October 21, 4:30 ET
The minutes from the BOE’s October meeting will be released on Wednesday, and while we already that they left rates unchanged at 0.50 percent and made no changes to their quantitative easing program, there are a variety of potential comments that could impact the British pound. First, the vote count is likely to show the Monetary Policy Committee (MPC) members were unanimously in favor of neutral policy for both the Bank Rate and the Asset Purchase Facility (APF), but any dovish deviation in this would trigger an immediate pullback in the British pound. The other possible trigger pertains to outlooks for growth and inflation, particularly upgrades or downgrades from previous forecasts, as this would lead traders to shift their expectations for interest rate decisions in 2010, with Credit Suisse overnight index swaps currently pricing in 86 basis points worth of rate hikes by the BOE over the next 12 months.

•    UK Gross Domestic Product (3Q A) – October 23, 4:30 ET
Has the UK finally started to emerge from recession? Traders will get a better official sense on Friday as the advance reading of Q3 GDP will be released. The quarterly rate is projected to rise for the first time since Q1 2008 by 0.2 percent, while the annual rate is anticipated to edge up to -4.6 percent from a record low of -5.5 percent. Overall, there are some upside risks for this report, as the purchasing managers’ index (PMI) for the services sector held above 50 in July, August, and September, indicating an expansion in activity. On the other hand, PMI for the manufacturing sector edged above 50 in July, only to drift down to 49.5 by September. All told, any positive quarterly GDP result would likely yield a very strong reaction from the British pound, but if the figure continues to signal a contraction in the UK economy, the currency could drop sharply on speculation that the BOE will have no choice but to expand their quantitative easing program later in the year.

•    US NAR Existing Home Sales (SEP) – October 23, 10:00 ET
The National Association of Realtors’ index of existing home sales is expected to have risen 5.9 percent for the month of September to an annual rate of 5.4 million, the highest in just over two years. Other factors to keep in mind are supply levels and median prices, both of which have fallen steadily to 8.5 months and $177,700, respectively. As with housing starts and building permits, the federal government’s tax credit for first-time home buyers of up to $8,000 is likely to remain supportive of demand through the end of the year. However, if the program expires as planned on December 1, the growth we’ve started to see in the housing sector could start to wane.

By Daily FX -

The dollar was able to relieve the pressure of suffering its worst trend on recent record by clawing out the first bullish close in eleven consecutive trading days; but that does not mean the burdened currency is necessarily primed for a true reversal. While this currency is arguably oversold on a fundamental basis; the same drivers that ushered it to its yearly low last week are still in play.

US Dollar Overdue for a Technical Bounce, But Fundamental Reversal…

Fundamental Outlook for US Dollar: Neutral

-    Speculation for rate hikes deferred as fundamentals temper exuberant risk appetite
-    The steady charge in risk appetite keeps the dollar on the short side of carry interests
-    Sentiment can often run askew of fundamentals; but what do technicals say about the dollar?

The dollar was able to relieve the pressure of suffering its worst trend on recent record by clawing out the first bullish close in eleven consecutive trading days; but that does not mean the burdened currency is necessarily primed for a true reversal. While this currency is arguably oversold on a fundamental basis; the same drivers that ushered it to its yearly low last week are still in play. The pace of the economic recovery, growing financial concerns and a Fed struggling to keep pace are all prominent concerns when gauging the long-term health of the dollar; but all of that is overshadowed by the immediate and market-wide preoccupation of risk appetite.

Last week, a Bloomberg survey of investors found the market was the most bearish on the dollar in 18 months. Where does this speculative grade come from? The economy is still dealing with an economic recovery and government deficits are a genuine concern; but most of the world’s largest economies are suffering with the same dilemma. The real weight on the dollar is the steady revival of risk appetite over the past six months. Following the necessary period of consolidation after the worst of the financial crisis, capital started to slowly work its way back into the speculative arena. Initially, interest was from early adopters; but the draw of capital gains was strong enough to start the flow from deeper pools of wealth in “risk free” areas. Where do these funds go? It certainly finds its way to US equities and other relatively-risky assets; but when it comes to the yield bearing instruments, the American products can’t compete. The benchmark, 3-month Libor rate dropped to a new record low (0.28948 percent) this past week and subsequently was depreciated to a discount against its Japanese (0.34875 percent) and Swiss (0.29667 percent) counterparts. Does the dollar realistically make the ideal funding currency? No. The Fed will certainly turn to a hawkish policy stance well before the other two, it has the potential to take a more consistent hawkish path, deficits are a problem amongst all three and the foundation for a true recovery is most stable in the US. As soon as US rates recover, risk-seeking capital will once again flow into the world’s financial center.

In the meantime, we may see a shift in sentiment that could benefit the dollar’s safe haven status. The broader markets have rallied consistently for months – despite a fundamental picture that has changed pace little since the initial reversal. Naturally, a wave of profit taking is highly probable. And, considering the advance to this point has been heavily dependent on steady capital gains, a correction could be sharp and aggressive. There are many different potential catalysts for such a turn; but in the end, the shift in optimism will likely develop naturally. Nonetheless, we should keep an eye on a few specific developments. Reports suggest that lending to consumers has dropped at its fastest pace since the Great Depression; yet leverage has returned to levels last seen since before the 2007 meltdown. This is an imbalance that will lead to problems later down the line if not corrected. Also, the Federal Reserve and White House have both voiced concern over the commercial real estate debt market. The former is looking into major banks’ exposure to this asset class; but the term ‘stress test’ is not being used.

Though it is vital to keep abreast of the health of risk appetite; we shouldn’t ignore the influences of data and growth forecasts. The economic docket is light next week; but durable goods orders and housing data (existing sales, new home sales) can supply short-term volatility. It is the FOMC that tops the list – not with a possible change in the benchmark, but commentary that can move up the time table for a hike. Data aside, the US/China trade spat hints at a growing concern with protectionism which may come under scrutiny at the September 24/25 G20 Meeting. Exit strategies, financial regulation, banking compensation are all on the topic list; but not currencies. – JK

By DailyFX -US Dollar:

Fundamental Outlook for US Dollar: Bullish

- US Retail Sales disappoint and the US Dollar rallies
- Federal Reserve’s interest rate decision sparks impressive US Dollar volatility
- Forex options and futures sentiment suggests USD may continue rallying

The US Dollar fell near fresh year-to-date lows versus the Euro and other major counterparts, but a sharp end-of-week reversal suggests that the downtrodden Greenback could stage a larger recovery. Impressive S&P 500 rallies played a large role in dollar weakness. A late-week US University of Michigan Consumer Confidence nonetheless proved sharply disappointing, and the key risk sentiment barometer turned notably lower into the week’s close. The strongly-correlated safe-haven US currency continues to take its cues from risky assets, and a true turnaround in stocks could herald an accelerated USD correction. We feel that a sustained US Dollar rally is almost inevitable, but timing the turn remains extremely difficult and we’ve thus far been early in our calls for Greenback strength. Increasingly one-sided sentiment nonetheless that Friday’s USD rally could be the start of a bigger move.

Limited US economic event risk in the week ahead leaves volatility expectations noticeably lower, but the dip hardly precludes short-term breakouts. Last week’s string of top-tier economic reports underlined the fact that forex traders still care about economic data, but market reactions are not always intuitive. Indeed, the dollar has frequently rallied on a number of disappointing US economic data releases. The strange dynamic owes itself to the USD’s strong link to risk sentiment and the S&P 500. When the S&P gapped lower following a clearly worse-than-forecast University of Michigan Consumer Confidence report, the US Dollar rallied sharply against the Euro and other key counterparts. If we can expect similar price action in the days ahead, US Dollar bulls should hope that domestic economic sentiment has likewise taken a turn for the worse. Recent Consumer Confidence figures suggest future consumption-linked reports may similarly disappoint.

Foreseeable highlights in the week ahead include Treasury International Capital (TICs) data, Housing Starts and Building Permits reports, and an end-of-week Existing Home Sales release. The first report may prove especially interesting to recently-skittish US Treasury Bond traders, as it will underline the health of foreign demand for US Dollar asset classes. Much was made of a “failed” US Treasury auction at the end of July, where demand for 2 and 5-year Treasury Note was sharply lower than expected. Commentators suggested that supply of US Government debt had far outstripped demand and Treasuries tumbled on the news. Recent 30-year bond auction results nonetheless showed healthy demand for long-term debt—that which is particularly susceptible to fears of excessive government deficits and creditworthiness. We here at DailyFX could not help but notice that the news coincided with the Fed’s aggressive balance sheet expansion on the week. Indeed, the Fed’s Quantitative Easing measures have explicitly purchased Treasuries and likely overstated the health of demand for US debt. The TICs report will provide a breakdown of foreign purchases and demystify the source of robust 30-year bond demand, and any signs of weakness in foreign purchases could have noteworthy effects on the US Dollar and domestic stock markets.

Prominent housing data could likewise drive volatility in the US S&P 500 and the Greenback, but results for the choppy data series are especially difficult to handicap. We will clearly keep a close eye on the S&P and other risky asset classes through upcoming trade. Whether or not the US dollar can finally stage a comeback will likely depend on the trajectory of financial risk sentiment. -

By Daily FX -

A recent divergence between the Euro futures contract and the US dollar index is just one piece of evidence suggesting that the EURUSD has reversed course.  Additional evidence includes a long term cycle, wave structure at multiple degrees of trend, and recent momentum considerations.

Market turns almost always occur with divergence.  The most commonly recognized divergence is momentum (such as RSI) divergence whereas a new high is not confirmed by a new high in momentum and vice versa.  A different kind of divergence occurs when similar markets fail to confirm new highs or lows.  Equity technicians watch the Dow Industrial average and the Dow Transportation average at potential turning points.  If one index fails to confirm the other’s new high or low, then the probability of a reversal is increased.  This dynamic has occurred on 3 occasions since mid 2008*.

July 2008: Euro trades above prior high set in April 2008 but USD index fails to drop below April 2008 low – USD bullish reversal

March 2009: USD index trades above prior high set in November 2008 but Euro fails to drop below November 2008 low – USD bearish reversal

Now: USD index trades below prior low set in December 2008 but Euro fails to exceed its December 2008 high – USD bullish reversal?
*there have been other instances of this divergence, but I am only showing the most recent instances in this report

Euro / US Dollar

This is a chart that I have shown numerous times over the last year.  It is important to keep in mind how important a USD turn may have occurred at 1.6000.  Since the end of the Bretton Woods era, the EURUSD (DEM rates are used before 1998) exchange rate has exhibited a long term rhythm of roughly a decade up and six years down.  If the rhythm holds, then the EURUSD is in a multi-year bear market.

Euro / US Dollar

Wave structure is in agreement with the roughly 10 year up / 6 year down sequence.  While not perfect (what real life wave count is perfect?), the decline from 1.6000 is characteristic of an impulse (wave 5 truncated).  Given the amount of time that the consolidation since has consumed, there is little doubt that everything since October 2008 is a correction.  Although some may have qualms with labeling the rally from 1.2454 as a truncated wave C, there is strong evidence that this is the correct interpretation.  The rally from 1.2454 is a clear 5 wave affair (C waves are in 5 waves).  Wave v of C is a diagonal with a textbook throwover (in which price exceeds the top diagonal line before reversing).  RSI divergence is present at the recent high as well.  A view of the weekly chart will show that last week’s price action traced out a key reversal.  Sentiment figures, including COT data, warn of a turn.  On a weekly closing basis, last week’s high is over 250 pips higher than the December high.  On a daily closing basis, last week’s high is just several pips shy of the December high.  This may be explained by the lack of liquidity that is common in December.

Euro / US Dollar

Finally, the short term pattern confirms the bigger picture bearish view.  The decline from 1.4452 is in 5 waves and 5 wave moves occur in the direction of the larger trend.  One more low (below 1.4103) may be required in order to complete the decline from 1.4452 but a correction; back to at least 1.4223 and possibly 1.4300 will present an opportunity to sell the EURUSD with a stop above 1.4452.

Jamie Saettele publishes Daily Technicals every weekday morning (930 am EST), COT analysis (published Monday mornings), technical analysis of currency crosses throughout the week (EUR on Tuesday, JPY on Wednesday, GBP on Thursday, AUD on Friday), and the DFX Trend Index every day after the NY close.  He is also the author of Sentiment in the Forex Market.  Follow his intraday market commentary at DailyFX Forex Stream.

By ActionForex -

Sterling tumbles sharply in an otherwise quite market on talk that UK would slump into a Japan-style “lost decade”. There are speculation that BoE will use the Quarterly Inflation Report to be released this Wednesday to signal the risk of falling into a trap debt deflation and that was the main reason that the bank extended its asset purchase program last week. Former MPC member Wadhwani also said that US is tracking the path trodden by Japan in the 90s. He said that the bounces in three to four quarters of decent bounce would be seen by the bounces are driven by temporary factors only. He expects second half of 2010 would be even more difficult in UK.

Elsewhere, dollar remains generally steady against most major currencies as consolidation continues. The Japanese yen recovers mildly in general but key short term support levels are still holding. Note that as mentioned before, commodity currencies remain relatively firmer in general. However, some additional pressure might be seen in near term, considering that Gold’s dive below 950 level is suggesting a short term top is in place there.

Data released earlier today saw Eurozone Sentix Investor Confidence improved more than expected to -17 in Aug. Japanese current account rose more than expected to 1.8T JPY in June. Machine orders rose more than expected by 2.7% mom in June. Economic watcher sentiment rose slightly to 42.4 in July but fell short of expectation of 43.4

.

GBP/USD Mid-Day Outlook

Daily Pivots: (S1) 1.6613; (P) 1.6720; (R1) 1.6790; More

GBP/USD’s fall from 1.7043 extends to as low as 1.6581 so far today and at this point, intraday bias remains on the downside for further decline. As discussed before, with 4 hours MACD staying negative, a short term top should be in place at 1.7043 already. Break of 1.6338/6582 support zone will confirm this case and target 1.5983 support next. On the upside, above 1.6717 minor resistance will turn intraday outlook neutral and bring recovery. But another fall is still in favor as long as 1.7043 resistance holds.

In the bigger picture, the sharp reversal from 1.7043 argues that whole rise from 1.3654 has possibly completed with five waves up already, on bearish divergence condition in daily RSI. Break of 1.6338/6582 support zone will solidify this case and turn focus to 1.5983 support for confirmation. Also, note that, whole rise from 1.3503 is treated as correction to down trend from 2.1161 only is expected to conclude inside resistance zone of 1.6428/7332 (38.2% and 50% retracement of 2.1161 to 1.3503). Completion of rise from 1.3654 will also indicate that such correction from 1.3503 has completed too. In such case, deep decline should be seen to send GBP/USD through 1.3503 low eventually. On the upside, in case of another rise, we’d continue to monitor for reversal signal as GBP/USD approaches 1.7332 fibo resistance.

We were watching the open last night for signs of continued USD strength from Friday, but the last 15 hours have been very quiet. EUR/USD (current bid 1.4176) is in a tight range.

Without any follow through of lower EUR/USD we will put back on our full position of long EUR/USD.

We originally bought at 1.4059 on July 30 (http://www.backbayfx.com/blog.php?action=fullnews&id=140) with a target somewhere in the 1.47xx handle. Friday morning we noted the price action and the distinct lack of short EUR/USD commentators so we took off half our position before the numbers at 1.4360.

We want to pick up our full position again but not at market, there may still be room for a real wipeout move this morning. We will use a Buy Limit order at 1.4125 to pick up the other half of our order today. If we do not get filled today, we will look to buy at market during the Asia Pacific session tonight.

We will keep our Stop Loss level of 1.3750 in tact for the full EUR/USD position.

Stay Nimble!

Stephen Leahy
Back Bay FX Services, LLC
www.backbayfx.com

By DailyFX -