Derivatives houses sold at least EUR5 billion (USD4.5 billion) worth of one-month euro calls/U.S. dollar puts last week as traders unloaded out-of-the-money options in preparation for what is expected to be a listless last week of the year in the foreign exchange market. Sales of euro calls with strikes at USD0.91-0.92 were most prevalent, according to one trader. "Everyone is selling time decay--people they don't think it is valuable to own the one-month over Christmas, which it isn't, because the fx markets historically don't move much over that time," he said. Spot was at USD0.8990 Wednesday. One-month euro/dollar implied volatility sank as a result of the selling, falling to 8.8% Wednesday from 9.4% at the start of the week. Traders predicted vol will go lower before the new year after which it is expected to recover.
Neil MacKinnon, a senior currency strategist at Merrill Lynch in London, said the options market is reflecting that the euro has been range-bound of late. "People are quite happy to sell calls around USD0.91-0.92. and then you have the time decay factor," he said. He added time decay is more significant than it was last year because the euro has been range-bound this year, whereas last year punters expected it to post significant gains early in January. Expectations were that the euro would rally and reach parity but it did not, so traders are being more realistic this year, he noted. MacKinnon said two other factors are also limiting upside potential for the euro: the pending introduction of notes and coins, which could be a logistical mess, and possible inflationary effects from rounding-up, which could impact the European Central Bank's monetary policy and thus euro-zone growth.
EUR/USD Spot & One-Month Implied Volatility
Source: J.P. Morgan
