Risk reversals are an FX option contract that can profit from FX volatility and they are challenging a critical level in EUR/USD right now and that matters.
Option risk reversals can tell casual observers in which direction FX volatility is more likely - typically the most vulnerable side of a currency pair.
EUR/USD risk reversals have seen their long standing implied volatility premium for EUR puts over calls (EUR/USD downside over upside option strikes) trending lower over recent weeks.
The casual observer can therefore conclude that there's less perceived risk of EUR/USD falling than gaining.
However, the benchmark 1-month expiry 25 delta risk reversal has now almost completely erased that downside strike premium.
If it flips to a EUR/USD topside volatility premium, it means broader EUR/USD implied volatility and the price of options would gain with spot and signal expectation of more EUR/USD topside potential.
EUR/USD implied volatility already appears poised for further gains, which the risk reversals suggest is more likely to come from further EUR/USD gains.
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