The euro's surprise gain against the U.S. dollar last week caught fx options players off-guard, triggering a rush to cover short positions. The single currency jumped to USD1.2077 last Wednesday, up from USD1.198 at the start of the week, while implied volatility came off slightly reaching 8.90% Wednesday, from 8.98% last Monday.
"The market has got a bit short gamma," said one trader, explaining how speculative accounts were covering their short options positions by buying front-end euro calls and dollar puts. Most were buying at-the-money options, but some were also buying euro calls at USD1.22, which is seen as a key barrier, he added. One-month and one-week options, covering next week's U.S. payroll data, were popular with speculative accounts, but traders said longer-dated options were not heavily bid.
The euro gains against the greenback were linked to respective money-market curves, explained a trader at a European house. Speculation over rate rises in the euro zone pushed the euro curve steeper and the single currency higher, while at the same time the U.S. rate curve inverted slightly, he noted. Ian Stannard, fx strategist at BNP Paribas in London, agreed, "[Money-market curves] are a powerful driving force in these markets." Stannard said he expects the euro to strengthen further this week, possibly moving out to USD1.23.