Nov 26 (Reuters) - The FX volatility upon which options thrive is an unknown, yet key part of their premium, so implied volatility is used as a substitute. A sharp increase in overnight expiry NZD related implied volatility since including Wednesday's Reserve Bank of New Zealand policy announcement, shows that option dealers are expecting a significant FX reaction.
Overnight NZD/USD implied volatility has surged from 13.5 to 21.0, driving the premium/break-even for a vanilla straddle from 33 to 51 USD pips in either direction. AUD/NZD premium gains are even more pronounced, with implied volatility jumping from 6.5 to 15.75 and increasing the break-even range from 30 to 73 NZD pips in either direction.
These prices match those quoted for the Oct. 9 RBNZ policy decision, when they slashed rates by 50 bps and sent NZD/USD plunging from 0.6141 to 0.6053. At the time, the RBNZ emphasized that policy remained restrictive despite inflation returning to target, fuelling market speculation of further aggressive easing.
Interest rate markets are now pricing in 60 bps of cuts for Wednesday, leaving a 40% chance of a 75 bps move. This explains the elevated FX volatility risk premium in NZD-related options.
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(Richard Pace is a Reuters market analyst. The views expressed are his own)
((Richard.Pace@thomsonreuters.com))
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