Hedge funds and bank prop desks surprised the market Tuesday by buying long-dated euro/U.S. dollar and dollar/yen volatility, reversing months of selling and driving up implied volatility levels from multi-year lows. One-year implied volatility for EUR/USD picked up from a 10-year low of 7.5% Monday to 7.765% Wednesday, and one-year implied vol for USD/JPY traded up to 7.6% Wednesday.
"Yesterday and today, clients were buying options," said one New York trader Wednesday. "You haven't seen that in a while." A steady sell-off of volatility by banks, combined with tightly range-bound spot levels, had driven down long-dated EUR/USD and USD/JPY implied volatility levels since the summer.
The reversal apparently was triggered when several funds started buying small volumes of volatility, which the market noticed and then imitated. "The bid today came out of nowhere," a trader said, adding, "Traders are like lemmings." One trader put the week's volumes up to Wednesday at twice as much as for any week since the summer, but added, "No big sizes were going through. Even a couple of buyers make it seem like a different environment." The most popular trades were six-month to one-year euro/dollar at-the-money straddles, traders said.
EUR/USD spot was relatively unchanged at USD1.2715 Wednesday from USD1.2701 last Wednesday. It has traded within a range of USD1.25 to USD1.30 since April and within USD1.265 to USD1.295 since July. "Those are exceptionally narrow ranges," said Dustin Reid, senior fx analyst at ABN AMRO in Chicago, noting the firm expects euro/dollar to break out of range and trade as high as USD1.31 by year-end.
