Editor's note: Volanthology is a multi-part series on volatility ("vol"), the various means of tracking it, and incorporating vol assessments into trading and investment research. Part 1 introduced historical and implied volatility, the VIX and other equity volatility indexes. Part 2 looks at FX Volatility Indices and other measures of currency vol.
Despite what you read in the papers and see on the business reports, there's a lot more to volatility than VIX—the CBOE Volatility Index, aka "the fear index."
Sure, because VIX is based on the implied volatilities of a basket of options on the S&P 500 Index (SPX)—a broad-based market barometer—VIX can be a handy, one-number snapshot of the state of stock market vol. Well, at least the consensus estimate of expected volatility over the next month or so, given the prices of options on SPX.
The Volanthology series is designed to showcase volatility beyond the VIX—across asset classes and across the globe. Some traders and investors use vol to help with portfolio selection, asset allocation and diversification, and for some, even market timing. This installment asks the question, "How volatile is money?"
A Quick Tour of the World of FX
Since this series takes a tour of volatility indexes, it's appropriate to start from a global perspective, looking at foreign exchange (FX) vol.
Why should you care about the volatility of foreign exchange rates? First off, FX touches many of us on a daily basis, from the stuff in our shopping carts to the cars in our driveways to the gadgets in our homes. Foreign currencies fluctuate for reasons similar to those of other asset classes—interest rates, inflation, economic growth, and future expectations—but with FX it's these economic dynamics relative to those same dynamics in other nations' currencies.
In other words, FX vol can be viewed as fluctuation in the value of your money, relative to its value elsewhere. For more on foreign currency dynamics, please refer to this recent primer.
FX Volatility Indices
CBOE, the exchange group that publishes the VIX, teamed up with futures exchange CME Group to track several FX volatility indices:
- CBOE/CME FX Euro Volatility Index (Ticker symbol: EUVIX)
- CBOE/CME FX Yen Volatility Index (Ticker symbol: JYVIX)
- CBOE/CME FX British Pound Volatility Index (Ticker symbol: BPVIX)
These three indices use a methodology similar to that of the VIX—they track the implied volatilities of baskets of options tied to CME Group futures contracts, normalized to a 30-day constant maturity. How volatile have these currencies been over the past few years? Have a look at figure 1 below. To view in the thinkorswim® platform, under the Charts tab, type in one of the ticker symbols above.
Want to see the implied volatilities of other currencies? The thinkorswim platform can give you access to options on a number of foreign currencies—the euro, pound, and yen, of course, but also the Canadian dollar, Australian dollar and Mexican peso, to name a few. For example, figure 2 shows the implied vol of options on Canadian dollar futures, with 42 days left before expiration.
Currency volatility can help an investor assess potential risks in certain parts of the world. It may help investors understand the dynamics of the prices of imported goods. And if you're an active trader in search of price action, following the volatility in asset classes such as FX might help you find some opportunities beyond the world of stocks and stock indices.
Futures and Forex trading involves significant risks and is not suitable for all investors.