GBP/USD implied volatility, which determines the price of FX options, is trading at its lowest since 2014 and carries no directional premium, according to one-month risk reversals nL1N2AB09X.
However, GBP/USD actual/realised volatility (fair value measure) has been outperforming implied volatility for a couple of weeks and rewarding option holders.
In other words, GBP/USD has been moving more than the premiums paid for the options, so how do FX option traders profit from this? Assume a basic one-week at-the-money straddle, with a strike near the current GBP/USD spot rate at 1.2950.
The owner has the right to buy or sell a predetermined amount of GBP at that strike at expiry as his insurance.
So whenever GBP/USD falls below 1.2950 he can buy it, and sell on gains above.
The aim is to capture more GBP pips than the initial premium paid for the option.
As long as GBP/USD remains volatile, the options can offer unlimited returns.
With implied volatility so low, the premiums are minimal, thus increase the risk versus reward potential.