Dollar Gains Keep Traders Busy

The U.S. dollar gained steadily against the yen in the spot market last week, prompting solid demand for dollar/yen upside options. Dollar/yen had been close to yearly highs the previous week, but last week players were buying into the view the rally is not yet over. The greenback climbed to JPY116.805 Wednesday from JPY115.185 last Thursday, while implied volatility rose slightly to 8.01% Wednesday from 7.75% last Thursday.

"There is a lot of interest in the upside of the dollar/yen," said one trader, noting that investors are taking a bullish view on the dollar and selling front-end options. Typically, players were buying one-week calls, striking at JPY116 with knockouts above JPY118.

David Woo, head of global FX strategy at Barclays Capital in London, said the yen's decline since the Japanese election in July surprised investors, the consensus of whom believed the yen was undervalued. "Volatility has been well contained despite spot moving higher," Woo said. "But that could change."

He said, and traders agreed, volatility will likely move in line with spot for the next few days or even weeks. But they noted, if barrier positions are knocked out at JPY119, that could increase volatility dramatically. "If that happens," a trader said, "All bets are off."