Low implied volatility on the euro/U.S. dollar last week prompted speculative players to buy up cheap euro puts, looking to profit from the single currency's weakness. The euro fell to USD1.2930 last Thursday in the spot market, but this was a small drop from USD1.2979 at the start of the week. The range-based trading kept implied volatility low at 8.3%, making it an ideal time to buy options.
Traders reported strong demand for options on the euro's downside, with players buying euro puts with strikes around USD1.25. Most were buying one-month or two-month options, but there was also some demand for out-of-the-money one-year euro puts with strikes at USD1.10. One trader explained USD1.2830 is a key spot barrier and speculative players were preparing for the euro to push through this barrier and fall to the USD1.25 level. The market is pricing in a U.S. rate hike, he explained, and this is putting downward pressure on the euro. The lack of firm signs of a European economic turnaround is also causing problems for the single currency, he added.
Tony Norfield, currency strategist at ABN AMRO in London, said although the low volatility environment was making options buying an attractive strategy, it was difficult to tell what direction to take. "We are in market confusion mode again," he said, adding problems of time decay over upcoming holidays and the event risk of the referendum on the European constitution are also muddying the waters.