The cost of U.S. dollar/euro options shot higher last week after WorldCom's revelation that it hid nearly USD4 billion in expenses fueled fears it may have to file for Chapter 11 bankruptcy protection and sparked a sharp decline in the U.S. equity markets. Mid-market one-month implied volatility rocketed to 13% by Wednesday afternoon in New York from 11.5% at the start of the week, according to traders. "WorldCom has made stocks collapse and has had an adverse effect on the dollar, it's purely that simple," said one trader in New York. He added that more than a yard of one-month euro calls/dollar puts struck at USD1.02 had gone through the market via several banks which he declined to name. Spot was USD0.9850 Wednesday afternoon, down from USD0.9945 earlier in the day. "Parity is a foregone conclusion, it's only a matter of whether it happens next week or next month. Or this week," a trader said. WorldCom's news also pushed 25-delta risk reversals in favor of euro calls to 1.5 vol from 0.9 vol earlier in the week.
Bob Gay, head of fixed-income research at Commerzbank Securities in New York, said the difference between short-term U.S. and European rates provides an attractive place for investors looking to park cash in these turbulent times. The 150 basis point spread is making short-term euro debt attractive and leading to a flight to quality. And incidents like WorldCom only serve to exacerbate the trend. "Europe has become an irresistible place to park your cash. 150bps is a lot in a risk averse environment and when rates are so low," he said. Gay predicts the euro will continue to strengthen and could hit USD1.05-1.10 by year-end.
