The dollar's depreciation against the euro to record lows last week has sparked a pick up in year end trading volumes in foreign exchange options. The move was sparked by exotic option market makers wanting to hedge their positions as many knock-out euro calls expire this month.
The dollar weakened to USD1.2382 against the single currency on Wednesday from USD1.2236 last week. Implied volatility dropped from 10.3% to 10.2% in the same period.
Short-dated implied volatility was being sold aggressively as the dollar fell. Traders said that vol and spot might fall even further as more traders exercise exotic option plays. Nick Parson, strategist at Commerzbank in London, said, "Below USD1.222 I think we'll see mass exits. It will be like shouting 'fire' in the cinema."
Parsons said that there was a possibility of a dollar recovery over the holiday period, but in the long-term the dollar's fall looks set to continue. Commerzbank's forecast for the end of 2005 is USD1.35, but Parsons said "I would be much happier if there were to be a shake-out soon."
EUR/USD Spot & One Month Implied Volatility
