THETRADETECHFX DAILY from the floor
What do you make of the gap between implied and realised volatility? What does it tell us about how the market is pricing risk? The gap between implied and realised volatility provides a useful gauge of how aggressively investors are pricing uncertainty and downside risks. From our perspective, the volatility risk premium is one of the indicators we follow when evaluating market sentiment and asset allocation opportunities.
What is particularly interesting today is that the gap remains positive but is no longer especially elevated by historical standards. Earlier this year, during the March-April risk-off episode, implied volatility surged well ahead of realised volatility. Since then, realised volatility has compressed to exceptionally low levels, while implied volatility remains closer to its long-run norm.
That is consistent with a market that has moved away from the elevated risk aversion seen in March and April and towards a more balanced assessment of the outlook: the signal has moved back to a more neutral stance.
To us, this suggests investors are no longer pricing acute stress, but neither are they fully embracing the unusually calm conditions seen in recent months. In other words, markets still appear willing to pay for protection against a potential reacceleration in volatility, which seems reasonable given how subdued realised volatility has become.
When volatility spikes after a geopolitical or macro shock, how do you manage positioning when the move can be sharp but short-lived? The most important point, however obvious, is that shocks are best managed before they occur, not after. Once a geopolitical or macro event hits the market, investors risk reacting too quickly, too late, or under the influence of emotions. By that stage, a significant part of the repricing has often already taken place, and from an asset allocation perspective, not every shock requires a portfolio response.
What matters is whether it has the potential to alter the underlying scenario. Many events create short-term volatility and attract considerable attention but ultimately have little impact on fundamentals.
This is why scenario analysis and risk identification are such critical parts of the investment process. The objective is to identify the main risks around the scenarios, assess their probability and potential impact, and reflect those risks in portfolio construction where appropriate. Equally important is having a clear plan for risks that could materially change the outlook.
Markets will always produce surprises. The key is not to predict every shock, but to engineer robust portfolios that correctly match the client risk constraints and have a robust framework in place and the discipline to stick to it when uncertainty rises.
‘ Market uncertainty has always been a certainty’
The TRADE catches up with TOMÁS GARCÍA-PURRIÑOS, senior asset allocation strategist, Santander Asset Management, to unpack how volatility is increasingly playing into FX trading strategies and how desks need to operate.
How are volatility signals feeding into wider FX and multi-asset decisions? Volatility remains an important input across both our multi-asset and FX decisionmaking process. Rather than focusing on volatility in isolation, we assess how changes in market conditions influence risk premia, trend persistence and, ultimately, the level of conviction behind potential investment opportunities.
The recent decline in volatility has been reflected across a number of the indicators we monitor. While calmer market conditions can be supportive for risk assets in general, from a relative-value perspective they often lead signals to become more neutral, as valuations and market pricing move closer to historical norms and opportunities become less differentiated.
In FX, we pay particular attention to how market volatility shapes carry opportunities, trend dynamics and broader risk appetite.
More broadly, it helps us calibrate portfolio positioning and assess whether the available opportunities offer sufficiently attractive risk-adjusted returns.
Is market uncertainty now a certainty? If so, how does that change the way desks need to operate? I would argue that market uncertainty has always been a certainty. In many respects, uncertainty has always been a defining feature of financial markets. The only constant in financial markets is change, and investors have never had the luxury of making decisions with complete information.
What has changed over time is not the presence of uncertainty, but the speed at which information and noise is processed and market narratives evolve. For asset allocators, that means uncertainty cannot be treated as an afterthought or a riskmanagement exercise applied once decisions have already been made. The implication is that uncertainty must be embedded in the process itself. It needs to shape portfolio construction, scenario analysis and the ongoing reassessment of investment views.
In practice, this means building portfolios that are robust across different scenarios, continuously reassessing assumptions as new information emerges, and maintaining the flexibility to adapt when the evidence changes.
The objective is not to eliminate uncertainty, which is impossible, but to incorporate it into the decision-making framework from the outset and ensure that portfolio positioning remains aligned with an evolving market environment.
22 THETRADETECHFX DAILY