Analyzing the time-varying properties of the EM FX spot-vol relationship reveals that the connection has weakened significantly over the past couple of years — with the exception of the INR.

In isolation, this reduces the attractiveness (for mark-to-market in P&L) of expressing dollar bullish positions in options but improves the attractiveness of options for dollar bearish exposure.

Based solely on the absolute spot-vol betas (change in vol points for a given percent change in FX spot), option positions to express a bullish dollar view are more appealing in INR, MXN and TRY — and for a dollar bearish view more attractive in CNH, SGD and BRL.

Implied volatility tends to fall (increase) when the dollar weakens (strengthens) against EM currencies. This is primarily due to the certain factors:

The speed and magnitude of EM depreciation phases tend to be larger than appreciation phases.

The underlying tail risk is for large depreciations in EM currencies rather than large appreciations. When the dollar is strengthening, volatility is bid up by investors that need to hedge their structurally long exposure in EM assets — and when the dollar starts selling off the lack of demand pushes volatility lower.

Given this historical relationship, owning dollar call options in bullish dollar cycles is generally preferred over dollar puts in dollar bearish cycles (abstracting from positive or negative carry, the absolute level of volatility, and the expected size of the movement in spot rates).

However, the spot-vol relationship varies across currencies and fluctuates over time, so understanding current trends is an important input to determine whether a directional trade should be entered in spot or options.

The volatility becoming less receptive to the spot FX movements, in this regard, we observe the relationship between spot FX rates and 3m implied volatility (weekly data) for the KRW, CNH, SGD, INR, MXN, BRL, RUB, ZAR, and TRY.

The positive relationship between USD-EM and implied volatility is clearly evident, but the other noticeable pattern is that in recent years the relationship has weakened quite significantly. Put another way, for a given movement in spot rates, implied volatility has become less responsive.