Hedge funds are dipping their toes back into the dollar/yen options market after months of absence, betting that eventual interest rate tightening by the U.S. Federal Reserve will help the greenback gain against the yen.
Dollar/yen‘s implied volatility, a gauge of how much a currency pair is expected to move over a given period, has come down to levels not seen since before Lehman Brothers collapsed in mid-September, sending global markets into a tailspin.
The decline suggests market stress has eased substantially and investor confidence has risen after the battering dealt by the global financial crisis, but it also implies lessening demand for options to hedge against a further surge in the yen.
«It means investors bruised in the past months have regained enough energy to stretch their arms and legs around, and some are starting to bet for economic recovery for the coming years, thinking the worst of the financial crisis is over,» said a senior options trader at a Japanese bank.
«Buying those long-term dollar calls with a big discount now would probably offer a better chance to make money than buying lotteries.»
One-month implied volatility for dollar/yen fell as low as 12 percent this month, dropping from a spike above 40 percent in October and breaking below the 15 percent that had been a strong floor as fears about the banking system persisted.
A drop in vols typically indicates limited spot price action is expected ahead and in fact dollar/yen vols tend to rise if it looks like the yen is appreciating.
The dollar has gained 8.5 percent since hitting a 13-year low at 87.10 yen in January and now stands at 94.50. It has come under renewed selling pressure this week and one-month implied volatility has ticked up a little to 14 percent.
Options dealers in Tokyo said hedge funds have been buying dollar call options as far out as seven years in recent weeks with strike levels above 120 or 130 yen.
Levels above 120 yen seem far off now, but the low probability of hitting strikes typically makes options premiums inexpensive. So for the hedge fund, it is not risking very much money.
Options buyers can hold them to expiry. Or they can make profits on growing delta — the probability that the strike levels will be hit in the agreed timeframe — by selling the option in the market as the spot rate nears the strike price.
Over the last 10 years, excluding the current crisis, dollar-yen has spent most of its time between 100 and 120.
Source: Reuters.
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