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. Read the rest of this entry »