Jan 23 (Reuters) - Overnight expiry FX options now include Friday's Bank of Japan policy decision and their premium/break-evens can offer clues about the perceived extent of the subsequent USD/JPY reaction.
Volatility is an unknown yet key part of an FX premium, so dealers use implied volatility as a substitute. Since its expiry included the BoJ decision, overnight USD/JPY implied volatility has jumped from 11.5 to 19.25. That shows the additional FX realised volatility that dealers fear the BoJ decision could create.
In terms of premium/break-even, the increased volatility has taken it from 75 JPY pips to 125 JPY pips. For a simple vanilla straddle, that is the amount of JPY pips which holders must capture, in either direction, to cover the premium.
For context, overnight expiry USD/JPY implied volatility was 26.0 or 170 JPY pips for the last BoJ meeting on Dec. 19 and current levels are the lowest for any BoJ meeting since June 2024.
Interest rate futures are nearly fully pricing in a 25bps rate hike from the BoJ on Friday, suggesting JPY gains could be modest if the hike proceeds without unexpected hawkish rhetoric. The greatest volatility risk for USD/JPY lies to the upside if the BoJ decides not to hike.
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Overnight expiry USD/JPY FXO implied volatility
(Richard Pace is a Reuters market analyst. The views expressed are his own; Editing by Alison Williams)