Speculation that Japanese policy markers are contemplating printing more yen to combat the country's spiraling deflation caused a surge in demand for yen puts/dollar calls last week. As a result one month yen/U.S. dollar implied volatility rose to 10.10% Wednesday from 8.5% a week earlier, according to New York-based traders. Spot rose to JPY126.50 last Wednesday from JPY125 a week prior.
Hedge funds and proprietary trading desks were the most active, buying up three-month yen puts/dollar calls as the one-month 25-delta risk reversal moved further in favor of yen puts, according to traders. Most of the options were at the money with strikes hovering around JPY126.50.
Greg Anderson, financial economist at FleetBoston Financial in Boston, predicted the dollar would remain strong against the yen over the next weeks because the market is anticipating that Japanese policy might shift dramatically by printing money and using it to buy up long-term U.S. government bonds. The move would cause a further weakening of the yen, while at the same time helping to lower U.S. interest rates. "Right now the market is sitting with long dollar options waiting for it to happen," he added. Anderson said, however, that any shock in the market, such as a swing in equity prices, could cause the yen to bounce back to JPY122 levels and traders to reverse their positions. "We think that there is a vulnerability to shock," he noted.
USD/JPY Spot & One-Month Implied Volatility
Source: J.P. Morgan