Pressure on the so-called volatility smile ,selling pressure has come in three waves.

Forex Option Gauges Suggest Risk Rally to Continue

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By DAVID WILLMER

Investor risk appetite continued to improve in Europe Friday and, if foreign exchange option market gauges are to be believed, the recovery has further to run.
Implied volatilities, a measure used to gauge expected future price movements, traded at multi-year lows in many currency pairings; a signal investors are becoming increasingly confident the period of turbulence and uncertainty that has rocked global financial markets may be reaching a conclusion.
"Pressure on the so-called volatility smile in the leading EUR/USD pair suggests a widespread belief in the rally continuing," said Olivier Korber, derivatives strategist at Societe Generale GLE.FR +3.45%.
Costs of protection for the three-month period in the leading EUR/USD pair have collapsed to 8.8% from 10.6% on August 31; 12-month implied volatility has fallen to 9.8% from 11.8%.
This selling pressure has come in three waves.
The first came in the wake of Federal Reserve Chairman Ben Bernanke's address at the Jackson Hole symposium of central bankers on August 31.
Until then, investors had predicted Mr. Bernanke would wait until December, or early 2013, before announcing fresh stimulus measures to boost the flagging U.S. economy.
The second came after European Central Bank policy measures were announced on September 6, followed by weak U.S. jobs data the following day.
By committing to unlimited short-dated bond buying, the ECB effectively removed the tail risk of a euro-zone break up. This boosted risk appetite further and sent the common currency higher.
Then, last Friday's poor U.S. jobs data stoked speculation the Fed would be announcing the next round of stimulus measures at this week's Federal Open Market Committee meeting.
With that outcome known, and fresh stimulus measures announced, investor risk appetite has received another shot in the arm.
Protection costs remain under pressure in most currency pairings; some trading at fresh multi-year lows.
Also worth noting is the performance of the risk reversal skews in euro-related pairings.
These widely watched measures, which reflect investor sentiment towards a currency, have also suffered sizeable losses.
In the EUR/USD pair, the added risk premium for benchmark 25-delta downside strikes in the three-month expiry traded at 0.8 volatility points Friday. At the beginning of August they were trading at almost two volatility points.
12-month traded at 1.9 volatility points in Europe Friday, down from 2.5 at the start of August and now at the lowest since May 2011.
This suggests demand for downside protection has dropped, investors are unwinding protection taken out in previous months and the euro's recovery is set to continue.
At 1235 GMT, EUR/USD traded at $1.3084.
(David Willmer is an FX Options Reporter for Dow Jones Newswires. He has over 20 years experience in the FX Options market and held senior positions at a number of major banks. His last position was at BNP Paribas BNP.FR +4.39%. He can be reached at david.willmer@dowjones.com)