Nov 7 (Reuters) - FX volatility is an unknown yet key part of an FX option premium, so dealers use implied volatility as a substitute. Overnight expiry options now include Thursday's UK and U.S. policy decisions, so their implied volatilities can offer clues on the perceived FX volatility reaction.

Overnight implied volatility reached extreme levels during this week’s U.S. election, as close polling and a binary outcome led to heightened FX market risk. Though it has since subsided, it remains elevated as traders await the two upcoming central bank meetings.

Overnight USD/JPY implied volatility is 20.0 - a premium/break-even of 128 JPY pips in either direction for a simple vanilla straddle option. For context, it was 27.0 or 173 JPY pips over the September 18 Fed decision. It was 14.0 or 90 JPY pips before including the U.S. election and 35.0 or 222 JPY pips when it did.

Overnight EUR/USD implied volatility is 15.0 (67 USD pips) from 14.0 (63 USD pips on September 18. It reached 29.0 or 132 USD pips over the U.S. election from 9.0 or 41 USD pips prior.

GBP/USD implied volatility includes both U.S. and UK rate decisions, but can only match the September 18 Fed inclusive peak at 17.0 or 92 USD pips in either direction. For context, it was 10.0 or 54 USD pips before including the U.S. election and 23.0 or 125 USD pips in either direction, when it did.

The Bank of England and U.S. Federal Reserve are both expected to announce 25 basis point rate cuts on Thursday, which may limit FX market reactions. However, elevated option premiums signal that FX derivative traders remain alert to potential volatility.

FX options wrap - Election risks shift to Trump trades

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(Richard Pace is a Reuters market analyst. The views expressed are his own)

((Richard.Pace@thomsonreuters.com))