Hedge funds and bank prop desks were selling short-term volatility last week across all currency pairs, driving short-term implied volatility levels to historic lows.
One-year euro/U.S. dollar implied volatility hit a five-year low Tuesday of 8.58% and other currency pairs were at similar lows. Anticipation of several weeks without economic data releases and upcoming public holidays prompted shorting out to the end of August.
"Hedge funds don't want to carry any long option positions into the end of summer," said one New York trader. "We haven't seen them putting on any new [short-term] positions, but they've been liquidating long volatility positions in the front end of most curves." At the same time, long-term players were looking to pick up volatility across pairs around three months and out.
The most popular trades were one-year euro/dollar at-the-money straddles and euro calls with strikes around USD1.385, traders said. EUR/USD spot was relatively unchanged at USD1.285 Wednesday from the week before. One-year EUR/USD implied volatility traded at 8.58% Tuesday from 8.75% the week before, and one-month implied vol closed at 7.35% Tuesday from 7.6% August 9. Cable saw slightly bigger moves and traders reported similar positions but less volume.
BNP Paribas's three-month weighted average fx volatility index of all major currency pairs traded near two-year lows at 7.96%. Naomi Fink, currency strategist in New York, said implied volatilities normally trough in August and uncertainty about macro-economic factors like monetary policy and the U.S. housing market compounded this year's vol crunch.