Interpreting Yuan Weakening Probabilities from Currency Options
Summary
The document discusses how reported probabilities of Yuan depreciation might be inferred from currency options. One proposed route is to use an option model’s delta at a relevant strike as an approximation, or to price a digital put using the full volatility skew. The source does not provide a derivation or enough market inputs to reproduce either calculation, so these are presented as possible interpretations rather than a confirmed account of the article’s method.
A second explanation cautions that option-implied probabilities are risk-neutral quantities, not direct forecasts of real-world outcomes. It suggests that the article may instead have treated put demand or open interest at different strikes as a proxy for market expectations. That proxy is ambiguous: positions can reflect hedging, risk reversals, or dealer hedging rather than a directional bet. The document therefore highlights the need to distinguish model-implied probabilities and activity-based indicators from actual beliefs about future exchange rates.
Key ideas
- An option delta may be used as a rough probability proxy, depending on the pricing model.
- A digital put priced using the volatility skew is another possible way to infer a risk-neutral probability.
- Risk-neutral probabilities are not the same as real-world forecasts.
- Open interest and put demand can reflect hedging structures rather than outright bearish views.
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Full text
# Calculating probability of Yuan's slump from options market # Calculating probability of Yuan's slump from options market http://www.bloomberg.com/news/articles/2016-01-06/if-options-traders-are-right-the-yuan-s-slump-is-far-from-over > Contract prices indicate a 79 percent probability that the currency will weaken this year and 33 percent odds that it will drop beyond 7 per dollar, a level last seen in 2008, according to Bloomberg calculations. The article was published on 7 Jan 2016. How was the probabilities regarding Yuan's slump calculated from the options market? ## Answer by dm63 (score 2, accepted) https://quant.stackexchange.com/a/22664 Most traders have no idea what N(d2) is. I see two possibilities (a) they're using the delta of the option for the relevant strike, as seen by whatever model they're using, or (b) they are pricing a digital put on the yuan, using the full skew structure (as a former trader, that's the way I'd do it). ## Answer by mxzzzzz (score 1) https://quant.stackexchange.com/a/22667 there is nothing to do with implied distribution from option prices calculated with Breeden-Litzenberer approach. this distribution is "risk-neutral" not "real". consider this as a sort of theoretical and artificial, regarding to real disribution, idea. in the article the author wrote about demand for puts. so they/she calculated these probabilities from outstanding notional of different options with respect to each other. put/call ratio, open interest for given strike / total open interest etc. these "probabilities" are just a proxy. for example, you see OI for puts for strike=7 jumped significantly, does it mean that someone bets on exchange rate decline? well, no. there are several possible reasons for this to happen. for example someone hedges his position in calls, or someone buys risk reversals (buy call, sell put). so you buy puts, market makers sells them to you and delta-hedges at same moment... no bets on downside.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.