COMMENT-Volatility is now the only FX constant and where options thrive

March 6 (Reuters) - FX options thrive on FX volatility which is now abundant due to shifting trade tariffs, growth outlooks, inflation and ultimately - monetary policy.

Options can capture volatility in any direction when paired with an opposing cash hedge, eliminating currency risk. As the spot market moves, the hedge is adjusted to maintain neutral exposure—typically once daily, but more frequently for short-dated expiries. This dynamic often pulls the spot market toward large, soon-to-expire FX option strikes, which is why it's useful to know in advance where they reside.

The buyer of an option gains the right to buy or sell a chosen currency pair at a predetermined strike price and expiry date. The premium they pay depends on factors such as time to expiry, the strike's distance from the current spot price, deposit rates, and currency forwards. However, volatility is a crucial yet uncertain factor—making implied volatility a key substitute in pricing.

If actual volatility exceeds implied volatility and/or implied volatility rises, the option's value can increase. This dynamic has realised big profits for EUR/USD FX option holders amid the recent spot and implied volatility gains.

If spot volatility declines, implied volatility should follow. However, given the current FX landscape, overall losses may be limited as the risk-reward profile of holding options remains appealing.

FX options wrap - EUR/USD leads a frenzied premium surge