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The FX options market has been actively managing the risk associated with USD weakness throughout most of 2025. However, the extent of these positions has likely seen a significant reduction since the decline of the USD, which had been halted in September. This shift has resulted in a more neutral directional bias among traders and market participants. Currently, the USD is gaining strength and has the potential to continue its recovery, particularly if the interest rate markets decide to postpone or limit the anticipated rate cuts for 2026. This situation could be further augmented by potential declines in equity markets, which may drive investors to seek safety in the USD.
In the EUR/USD market, risk reversals are showing a reduction in topside premiums, with the 1-month tenor approaching a neutral stance. There remains limited interest in hedging against a potential decline below the 1.1400 mark, despite the presence of significant support levels close to that figure. For traders interested in protection against further declines, acquiring EUR put options coupled with USD call options would serve as a hedge. This strategy could prove beneficial as a shift towards a downside skew in the market would likely result in an increase in implied volatility.
Meanwhile, GBP/USD option traders have been increasingly purchasing USD calls and selling GBP puts in anticipation of the upcoming UK budget announcement scheduled for next week. This budget is expected to exert ongoing pressure on the British pound. The implied volatility for the upcoming week has surged as the budget draws near, indicating heightened concerns regarding potential realized volatility tied to the budgetary implications.
In the USD/JPY segment, implied volatility saw a significant spike when spot prices broke above the 155.00 level and approached the high recorded in January 2025 at 158.08. Nonetheless, this volatility has since stabilized as spot prices fell back below 157.00. Risk reversals in this pair still indicate a bearish sentiment, as the risk of intervention by authorities is likely to limit any upward momentum. There has been relatively light demand for outright JPY calls; however, some substantial buyers have surfaced for strikes in the range of 160.00 to 165.00 for JPY put options against USD calls, particularly in the 3-month tenor this week.
In the AUD/USD market, the implied volatility gains have lessened, with the 1-month volatility retreating from a peak of 9.0 down to 8.5. There is a pivotal threshold just below prior support levels in the mid-64s, where a break could rekindle demand for options and yield rewards for option holders, especially in the context of declining equity markets.
The broader options market does not seem to reflect significant apprehension regarding a substantial recovery of the USD. This sentiment could be attributed to the prevailing belief that even if there is a missed rate cut in December, the terminal rate expectations, which hover around 3% for the end of 2026, would remain unchanged. Nevertheless, for investors who hold the view that the outlook for interest rates could become less dovish, thereby granting the dollar renewed strength, USD call options present a practical strategy for hedging against this potential risk.
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Patrick has been involved in the financial markets for well over a decade as a self-educated professional trader and money manager. Flitting between the roles of market commentator, analyst and mentor, Patrick has improved the technical skills and psychological stance of literally hundreds of traders – coaching them to become savvy market operators!