Mounting evidence of a global economic recovery has soured sentiment on the safe-haven US dollar among options investors, mirroring the prevailing weak stance on the currency in the spot market. Options market signals used to gauge bullish or bearish sentiment on currencies, called risk reversals, show a negative bias on the greenback against the euro, according to Reuters data.
A positive risk reversal means the volatility of call options exceeds the volatility of similar put options, implying more market participants bet on a currency's rise instead of a drop. "Dollar puts are in demand, suggesting expectations of dollar weakness. That, in turn, is embedded in a global recovery," said Andrew Wilkinson, options analyst at Interactive Brokers Group in Greenwich, Connecticut.
"Dollar weakness could have some way to run at least in terms of the mindset of investors." Expectations for the dollar's fall after last year's strong gains gathered momentum after signs that economies around the world are beginning to come out of recession. Japan, Germany and France have all posted positive growth in second-quarter gross domestic product. Even the United States, where the credit storm started two years ago, seems on a path to recovery.
STOCKS RALLY WORLD-WIDE This news sparked stock market rallies around the world and a dollar sell-off. The S&P 500 is up 13.6 percent so far in 2009, while the ICE Futures dollar index, a measure of the greenback's value against six major currencies, is down 3.8 percent this year after a 2008 gain of nearly 6 percent. Investors bought the dollar amid the worsening global financial crisis last year and sold currencies such as the euro and sterling as their economies sputtered.
But a more positive euro outlook has become more evident in recent sessions after the upbeat GDP readings in Germany and France. "There is an underappreciated story that Europe is recovering faster than we thought," said Richard Franulovich, senior currency strategist at Westpac in New York. "I think the euro story has further to run, which should argue for the euro touching $1.45 to $1.46."
In contrast, the Federal Reserve's commitment to keeping rates "exceptionally low for an extended period" suggests the dollar stands to gain less from rosy US economic news than the euro would from strong European data. That said, not all risk reversals are showing puts in the dollar. Risk reversals in the Australian dollar/US dollar, for instance, are showing a bias for Aussie puts and dollar calls.
That doesn't mean, however, that the options market is less bullish on the Aussie than the greenback. Traders said the decline in Aussie risk reversals occurred as the Aussie dollar topped near US $0.85 a few weeks ago. Many fear the Aussie is overvalued, and this caused a scramble for Aussie puts as downside protection against long positions in the currency or outright naked directional bets. Options dealers said this is a fairly common occurrence after a big rally in a currency.
DECLINING VOLS Views about an economic rebound also can be gleaned from the drop in implied volatility. Implied volatilities, or "vols", measure how much investors expect a currency to move in either direction in a given time. Declining volatility suggests the worst of the financial crisis may have passed and investors are once again comfortable taking risky bets.
Vols across all asset classes soared last year as the credit crisis hit financial markets, resulting in investment bank Lehman Brothers' collapse and insurer AIG's bailout by the US government. On Monday, vols of one-month euro/dollar options were at 10.55, declining from highs of 15.95 in June and 23.60 in January. Similar yen vols are at 13.05, down 21.7 percent since the year began.
Meanwhile, the CBOE Volatility Index or VIX, the S&P 500's implied vol measure often viewed as Wall Street's fear gauge, slid more than yen and euro vols, falling 72 percent since the peak last October. Analysts say options on dollar/yen and some of the yen crosses have become expensive relative to the VIX, which suggests yen option prices should fall further. Simon Smollet, FX options strategist at Calyon in London, said there is no sense for "yen cross activity to be significantly above that of the S&P 500."
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