Demand for short-dated options to buy dollar/yen has risen this week, suggesting investors are keen to protect their short dollar positions against sudden bounces even though they see the greenback staying weak. Having built up short dollar/yen positions during the US currency's tumble, investors are taking advantage of low market volatility to protect against any near-term dollar correction, pushing down one-week dollar/yen 25-delta risk reversals close to neutral levels.
Rising demand for short-dated dollar calls follows the dollar's rise close to 86.00 yen on Monday, recovering briefly from a 15-year low of 83.58 yen hit last week. While the move was fleeting, it highlighted the possibility the dollar's downtrend versus the yen will not be a one-way bet even as it approaches an all-time low of 79.75 yen. "The market wants to hold (the options) as a plaster. They've got big positions and, for not very much, they can insure against what may look impossible at the moment, but may be a possibility down the line," said Simon Smollett, options analyst at Credit Agricole CIB.
Along with the usual jitters of market volatility following US nonfarm payrolls on Friday, analysts say nervousness about yen intervention may escalate before a vote for the leader of Japan's ruling Democratic Party later this month. The outcome of a race between Japanese Prime Minister Naoto Kan and party powerbroker Ichiro Ozawa is too close to call, and some analysts say intervention speculation may intensify if Ozawa takes the reins of the party and becomes prime minister.
"CHEAP STOP-LOSS" Risk reversals, the premium required to hold a put or a call in a currency, are skewed towards yen calls in the one-week tenor at around 0.05, down from 1.0 a week ago. This indicates the premium required to hold a yen call has fallen from a week ago, and it now costs almost the same to hold a yen call or a put.
The risk reversal skew is the narrowest since March, when the yen was falling against the dollar. The move lower in yen calls over longer tenors has been muted, with 1-month risk reversals edging down to 1.3 from around 1.8 last week. One-month implied volatility has hovered around 12 percent or lower for the past month according to Reuters data, having fallen from around 18 percent hit in May.
This indicates that the dollar's 10 percent fall versus the yen has occurred in a relatively calm market. "Nobody seems to be in the market for dollar puts, which is a bit of a shock considering current spot levels," said Lee McDarby, corporate risk manager at Investec.
"Selling a bit of volatility around here looks like a good idea, or at least covering with some dollar calls given the value to be had if spot trades lower." Earlier this week, traders said demand had increased to buy dollar/yen options with a strike price of 85.50-86.00 yen for early next week.
This would cover the risk of the dollar appreciating - including any rise on better-than-expected US nonfarm payrolls due on Friday - without the commitment required to take on a long position on the US currency. Demand for dollar calls for less than one month with strikes at 87.00-88.00 were seen on Thursday. "They're doing it not for positioning, but for a cheap stop loss," a London trader said.
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