gld01 Gamma01 tradingfloor.com implied volatilities have started

http://www.tradingfloor.com/blogs/fx-options-update/chf-and-gold-unsafe-havens-amidst-volatile-options-market-2086739242

FX Options Update

CHF and gold: unsafe havens amidst volatile options market?

  More

Gustave Rieunier,yesterday17 August 2011

One particular topic dominated the media and financial market during the last few weeks - the U.S. downgrade. For a while there had been talk as to whether the United States was worthy of a AAA rating status. On 5 August this talk became a reality when Standard & Poor’s downgraded the U.S. credit rating to AA+. It was quite a statement that a major agency proclaimed its concerns regarding the enormous U.S. debt. The financial market as a result turned to risk-off mode, becoming extremely nervous and volatile with the consequence being stock selling and a flight to quality/safety. In the options market, we noticed trading patterns indicating panic, foremost in the so-called safe haven assets such as the Swiss Franc and gold, which gained strength with increased velocity as well as volatility.

For several days in a row EURCHF spot reached new record lows, as XAUUSD (spot gold) continuously saw new highs. During this period, option implied volatilities reached extreme levels, with sellers completely disappearing at times (especially in EURCHF). The following two charts show the 1-month implied volatility for EURCHF and Gold (note the recent spike!). It should be highlighted that EURCHF 1-Month implied volatility surged well above the levels seen at the end of 2008! Obviously this surge in volatility was not limited to the FX market: the VIX index, for instance, increased significantly during the same period.

EURCHF, 1month implied volatility
(source Bloomberg)

Gold (XAUUSD), 1month implied volatility
(source Bloomberg)

As usual, this large increase in volatility came hand in hand with a liquidity vacuum: bid-offer spreads exploded and market-makers all but disappeared. For instance, 1 month Gold vols went as wide as 7 vols when they are usually quoted between 1 and 1.5 vols.

Regarding the CHF, the moves turned to major concerns with politicians and the market eagerly awaiting this morning’s news from the Swiss National Bank. We saw a large amount of short-dated interest in the interbank market, with most investors wanting to buy options to protect themselves against large potential moves … and it should be noted that most of them were focusing on buying CHF puts, i.e. upside options. Indeed, rhetoric and potential action from Swiss officials have made the Franc a far less reliable safe haven! We are now up about 10 big figures from the lows seen last week, and the picture there is now one of two-way action rather than one of a sure bet. For instance, overnight 1.1625 EUR calls / CHF puts were being quoted 55/85 vols first thing this morning with spot around the 1.15 mark… very wide, and very high!

However, implied volatilities have started to ease off from last week’s high… and it seems "quieter" stock markets and FX markets (albeit relative to recent weeks' volatility) are putting pressure on the curves… and obviously any news of specific levels being targeted by the SNB would see further declines. Selling vols might be very tempting there to try to benefit from their unusual levels… but one must be careful not to be exposed to too many short dated options (i.e. short gamma). Large spot moves are still very much on the cards and directions are a lot harder to predict now: CHF does not appear to be a safe haven anymore … could it be as unsafe as housing investments?