BUZZ-COMMENT-Short FX volatility - the trade that keeps giving

Feb 18 (Reuters) - The FX volatility on which options thrive was plentiful at the beginning of Donald Trump's tenure as the 47th president of the United States, providing protection and returning profits for long volatility positions.

However, as the USD retreated from new 2-year highs and realised FX volatility became increasingly subdued, short volatility trades have emerged as the clear winners.

Volatility is an uncertain yet crucial factor in FX option pricing, prompting dealers to use implied volatility as a substitute. Any divergence between implied and realised volatility creates a tradable opportunity.

The simplest way to enter a short FX volatility trade is by selling an option and hedging the associated currency risk with cash. The seller earns a premium based on the option's implied volatility. If realized volatility declines and implied volatility falls, the option loses value, allowing it to be repurchased at a lower price or left to expire worthless.

Longer-dated options typically experience the largest premium fluctuations when implied volatility shifts. For example, selling 1-year expiry EUR/USD implied volatility at 8.0 in early February and buying it back at 7.0 today on a standard 30 million euro straddle would have yielded a 234,000 euro profit. In contrast, selling 1-month expiry EUR/USD straddles on the same notional amount when implied volatility was 9.0 in early February and buying it back at 6.9 today would have generated around 139,000 euros.

FX implied volatility remains under pressure as the broader USD consolidates its pullback from two-year highs to two-month lows. So far, there has been little urgency to take profits on short positions or re-enter long volatility trades. FX options wrap nL2N3P80GK

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