Currency Volatility World Tour: Foreign Exchange (Forex) Volatility

Currency Volatility World Tour: Foreign Exchange (Forex) Volatility

Key Takeaways

    There’s more to volatility than the Cboe Volatility Index (VIX), which measures the volatility of the S&P 500 Index (SPX)

    Learn about foreign exchange volatility, why it might matter to investors, and how to measure it

Despite what you may read in the papers and see on the business reports, there’s a lot more to volatility than VIX—the Cboe Volatility Index, aka “the fear index.”

Sure, because VIX is based on the implied volatilities of a basket of options on the S&P 500 Index (SPX)—a broad-based market barometer—VIX can be a handy, one-number snapshot of the state of stock market vol. Well, at least the consensus estimate of expected volatility over the next month or so, given the prices of options on SPX.

But the VIX is only one data point in one asset class. There are other volatility measures in the equities world, and there’s a whole host of published volatility indices in other asset classes, time horizons, and geographies. These alternative measures of volatility can help investors gauge uncertainty in a number of market segments.

In other words, there’s volatility beyond the VIX—across asset classes and across the globe. Some traders and investors use vol to help with portfolio selection, asset allocation and diversification, and for some, even market timing. Take the foreign exchange (forex) market, for example. A currency volatility index addresses the question, “How volatile is money?”

A Quick Tour of the World of Forex

Why should you care about the volatility of foreign exchange rates? First off, foreign exchange touches many of us on a daily basis, pretty much whenever we open our wallet or purse and swipe that card. From the stuff in our shopping carts to the cars in our driveways to the gadgets in our homes, the prices we pay for anything sourced outside our nation’s border is affected by the exchange rate.

“Volatility in the forex market affects us more often than one would think,” says Adam Hickerson, Manager, Futures & Forex at TD Ameritrade.

Foreign currencies fluctuate for reasons similar to those of other asset classes—interest rates, inflation, economic growth, and future expectations—but with foreign exchange, it’s these economic dynamics relative to those same dynamics in other nations’ currencies.

“Think of all the goods and services that occur outside of the U.S.,” Hickerson says. “Changes in currency rates abroad impact the prices producers pay for these goods and services, which can then have a downstream impact on what we pay as consumers. If a currency is more volatile relative to the U.S. dollar, consumers may expect more price fluctuations,” he says.

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Currency volatility indices can offer a snapshot of the expected fluctuation in the value of your money, relative to its value elsewhere. 

FX Volatility Indices

Cboe, the exchange group that publishes the VIX, teamed up with futures exchange CME Group to track several currency volatility indices:

    Cboe/CME FX Euro Volatility Index (ticker symbol: EUVIX)Cboe/CME FX Yen Volatility Index (JYVIX)Cboe/CME FX British Pound Volatility Index (BPVIX)

These three indices use a methodology similar to that of the VIX: They track the implied volatilities of baskets of options tied to CME Group futures contracts, normalized to a 30-day constant maturity. How volatile have these currencies been over the past few years? Have a look at figure 1. To view in the thinkorswim® platform from TD Ameritrade, under the Charts tab, type in one of the indices’ ticker symbols.

Currency Volatility World Tour: Foreign Exchange (Forex) Volatility

FIGURE 1: FX VOLATILITY EBB AND FLOW. Currencies have typically seen periods of volatility as well as periods of calm. For example, this chart shows the euro, Japanese yen (purple), and British pound (blue) in 2016. Note the big spikes during the summer 2016 Brexit referendum and the November 2016 U.S. presidential election. Data source: Cboe Global Markets, CME Group. Chart source: The thinkorswim platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Want to see the implied volatilities of other currencies? The thinkorswim platform can show you options on a number of foreign currencies—the euro, pound, and yen, of course, but also the Canadian dollar, Australian dollar, and Mexican peso, to name a few. For example, figure 2 shows the implied vol of options on Canadian dollar futures, with 42 days left before expiration.

Currency Volatility World Tour: Foreign Exchange (Forex) Volatility

FIGURE 2: FINDING IMPLIED VOL ON FUTURES OPTIONS. In the thinkorswim platform, under the Trade tab, click the ticker symbol dropdown box and select Futures to pull up a list of available contracts. Each option chain should show the implied vol. Data source: CME Group. For illustrative purposes only. Past performance does not guarantee future results.

Currency volatility indices can help an investor assess potential risks in certain parts of the world. It may help investors understand the dynamics of the prices of imported goods. And if you’re a qualified, active trader in search of price action, following the volatility in asset classes such as forex might help you find some opportunities beyond the world of stocks and stock indices.

Futures and forex trading involves significant risks and is not suitable for all investors.

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