Tariff news ‘ping pong’ gives FX options desks a headache

Dealers say Trump’s shifting deadlines sparked weekend trading rush and made it hard to monetise flows

Foreign exchange market-makers often say they prefer more volatile markets. But last week’s wild swings pushed many to their limits, as options volatility whipsawed on news of US president Donald Trump’s shifting tariff deadlines.

“This week felt like a month,” said a senior FX options trader at one US dealer, speaking on Thursday (February 6).

For most bank traders, the chaos began on February 1 when Trump announced tariffs of 25% on all goods from Canada and Mexico, effective from February 4.

The news sent traders rushing to their trading screens. The previous week, hedge funds had closed out many of their long US dollar call positions after Trump failed to announce tariffs on inauguration day – despite claims during his election campaign that he would impose them on “day one” – pushing JP Morgan’s Global FX Volatility Index to its lowest level in 24 months.

But the February 1 tariff announcements brought Canada and Mexico vols back into play, so bank traders tried to get ahead of the demand for topside USD calls during the illiquid weekend hours.

“You had the dollar gap stronger in thin liquidity. Nothing out of the ordinary or that there were problems, we just had to risk manage. It’s certainly not something we do every weekend,” says the FX options trader

Vol movement on the way down was as severe as on the way up, which usually doesn’t really happen

FX options trader at a European bank

Others found the going much tougher.

“When I logged in at 2pm on Sunday, all around spot market liquidity was very bad, and in options there was no market,” says another FX options trader at a European bank in New York.

“It wasn’t until a couple of hours later at about 4:30pm when [options] started in the broker market, and everything was super wide and super gappy. It clearly showed people were getting stopped out and panicking on the moves, even though Canadian dollar vols did not move that much higher.”

It was a completely different story when Monday afternoon New York time came around, after Trump announced a 30-day delay to the tariffs on Canada and Mexico.

One-week Canadian dollar vols dropped from 13.21 on Monday morning UK time to a low of 8.53 the following day. Demand for one-week USD calls against CAD via risk reversals also fell from 2.58 to 0.97 as interest shifted away from tariff trades.

Likewise, Mexican peso vols went from 19.97 to a low of 15.47 on February 4.

“The vol movement on the way down was as severe as on the way up, which usually doesn’t really happen,” says the FX options trader at the European bank.

“After a knee-jerk reaction, it usually takes a couple of days to go back to the same levels. But on Tuesday [February 4], everything was back to normal.”

Trump’s February 1 announcement was swiftly followed by a 10% tariff on all Chinese imports, effective from February 4. China responded by levying a 15% toll on all US energy imports. Trump also hinted that the European Union could be next to face tariffs.

In the vol markets, offshore Chinese renminbi (CNH) one-week vols fell from a high of 7.62 on February 3 to 5.95 the following day, while CNH risk reversals moved from 0.28 to -0.01, indicating a shift of demand towards USD puts.

From pillar to post

The senior FX options trader at the US dealer says the choppy markets had made it more difficult for market participants to take on positions.

“The headline ping-pong in the tariffs has not been easy. I think the threat of tariffs is now discounted quite a bit by the market, given we’ve had this multiple times where they were threatened and then quickly taken back,” he says.

He adds that the frequency of headlines causing markets to drastically reprice has made it difficult for dealers to monetise flows. “It can be difficult to market-make because everyone is the same way, and then it’s difficult to provide liquidity until you actually find the right level.”

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A G10 FX options head at a second European bank, however, says that while the market was busier, it was manageable as the majority of spot volatility, especially for USD/CNH, had normalised by the time London traders came online.

“By that time, you didn’t have to deal with a lack of spot liquidity, which would then feature into vols. So, the market settled down quite quicky,” he says.

But to some on the buy side, the markets last week seemed more chaotic than settled.

“Our portfolio managers were driven into trading when they didn’t want to, largely because of all the headlines. A lot of positions were stopped out,” says a senior FX trader at a UK-based asset manager.

Since the tumultuous trading sessions of last Monday and Tuesday, dealers say the majority of participants are taking profits on their post-inauguration trades, while selling vol has also become popular.

Options on realised volatility, for example, have been a common way for relative value hedge funds to short vol with limited downside.

Dealers say this week has signalled that the ‘strong USD’ macro view that the whole market was playing pre- and post-inauguration has materially changed. In fact, the dollar fell significantly against the Canadian dollar, renminbi, euro and Mexican peso.

“What you’re seeing now is a consolidation and when that happens, vols pull back and maybe the more natural flow from corporates and vol sellers dominates until the next theme is established,” says the G10 FX options head at the European bank.

Editing by Lukas Becker and Kris Devasabai