EUR/USD implied volatility spiked higher from record lows and risk reversals now trade at their highest volatility premium for EUR calls over puts in two years nL1N2A3035, but the options market may be overreacting to renewed risks for the pair.
Lack of realised volatility had forced implied volatility to record lows, with much of the market short.
So it was no surprise to see Friday's big, and rare, intra-day spot move spook dealers and fuel short covering.
Market makers are likely to be short some upside strikes above 1.1200, so the greater perceived risk of spot extending its gains can be blamed on the increased premium for EUR calls over puts on risk reversals.
However, EUR/USD spot is still well-contained in its long term 1.0879-1.1240 range and realised volatility trades well below implieds.
Without a continued push higher in spot, current implied volatility levels look expensive and may attract outright sellers, or buyers of range binary options to take advantage.