By Gertrude Chavez-Dreyfuss
NEW YORK (Reuters) - Foreign exchange markets are growing less fearful about the outcome of next month's U.S. presidential election, judging by the fall in longer-dated implied volatility on options, the main measure of how much risk is perceived.
Currency options investors are increasingly betting that Democratic challenger Joe Biden will conclusively defeat President Donald Trump, given his lead in prediction markets and national polls.
This can be seen in the fall of some prices for implied volatility, which measures how much the options market believes spot exchange rates will move over a given period and is distinct from actual or realized volatility.
Biden opened his widest lead in a month in the U.S. presidential race after Trump's positive coronavirus test as a majority of Americans believed he could have avoided infection if he had taken the virus more seriously, the latest Reuters/Ipsos poll showed.
Options are widely used to hedge against expected moves ahead of a major event. "Vol" is a key input in the price of an option and can vary for an instrument depending on supply and demand for options and time to maturity. The higher the volatility, the greater the uncertainty over a given term.
Options strategists pointed to flatter implied volatility curves for most currency pairs and said longer-dated volatility, three months and onwards, traded lower than the shorter-dated vols.
This suggested that investors are expecting less chaos and a calmer market weeks after the Nov. 3 election. The three-month volatility extends until December and any view or expectation of turmoil will be reflected in the options pricing for this period.
"The market is assuming that there is a higher probability of a Biden presidency and that there won't be as much uncertainty after the election as the market was previously thinking," said James Rider, research director, at currency advisory firm FXvolResearch in Vancouver, Canada.
The implied volatility used by banks to price three-month options on the dollar's exchange rate against the Japanese yen fell to a two-month low of 7.1%
This was significant, Rider said, because two weeks ago, the longer-dated dollar/yen volatility was higher than the front-end one, suggesting the market was betting on a contested election.
"My interpretation is that a little bit of risk sentiment has been taken out of the market," Rider said.
The decline in back-dated volatility occurred even after Trump's positive coronavirus test on Friday. He left a military hospital on Monday after a three-day stay, saying he felt much better.
Implied volatility on three-month dollar/Swiss franc options at 6.67%
To be sure, one-month volatility on dollar/yen options remained elevated. It hit a four-week high of 7.7% on Monday, but was last at 7.47% on Tuesday.
Stephen Innes, chief market strategist, at online brokerage AxiCorp, said that was probably due to expectations being split between a contested and uncontested election.
"There is still a chance that this election remains a highly contested affair, despite the fact that the market pricing the eventual winner is beginning to narrow to where the polls are. The market always remains very circumspect of polling numbers after prior voting debacles," he added.
Biden's odds on various betting websites have improved in recent days, with Smarkets.com giving the former vice president a 63% chance of winning the election, up from 55% before last week's chaotic presidential debate.
One-month vol on dollar/yen slipped to 7.41% after Trump called off virus-related stimulus talks until after the election.