AUD/USD: Bearish directional on Aus CPI, options hedging

By FXStreet FXStreet (Bali) – Australian CPI inflation numbers came lower across the board, taking the market certainly by surprise.

Short volatility option market to worsen AUD pain

The AUD/USD marked fell by over 60 pips immediately, with risks of bearish follow through significantly increased, not only judging by the divergence between what was expected and what the numbers show (increases chances of RBA easing in November), but also by the current options market positioning, which has been in ‘selling volatility’ mode since mid-September, suggesting that breaks of key levels (0.7165/0.72) risks being directional.

Background on short volatility risks

When option players sell volatility, most of the daily activity orbits around selling puts and calls (unlimited risk), as market makers and other participants aim to suppress the gap between implied volatility and historical. When the former is above the latter, as has been the case in the AUD/USD market since early Sept, the breakout of key support and resistance levels carries the risk of being directional in nature, as option players (short call/puts) must cover their unlimited risk exposure by going in the direction of the key breakout, as they fail to keep the underlying spot market within limited brackets.

Bearish directional risk in play

In the …read more

Source:: FX Street