Twenty-five delta one-month risk reversals showed a stronger bias in favor of euro calls/dollar puts in the last two weeks after the euro started to strengthen against the greenback. Traders said market makers were snapping up risk reversals in anticipation of further euro upside. The one-month risk reversal jumped to 0.81 in favor of euro calls/dollar puts Wednesday from 0.2 two weeks ago. Implied volatility shot up across the board. One-month vol was 12.1% Wednesday from 10.85% two weeks ago as the euro appreciated to USD0.8796 from USD0.8552 in the spot market.
Some traders feared implied volatility was too high and therefore entered trades where they were short vol but would still profit from a rise in the euro. One example is to sell one-year in-the-money euro puts with strikes around USD0.93 and buy one-year at-the-money euro puts. If the euro is above USD0.93 at maturity the trader walks away with the difference in the premiums. The trades were put on across the curve.
Kamal Sharma, currency strategist at Commerzbank in London, said the euro has been rising against the dollar because of a combination of the Latin American crisis dampening trading volumes, the continued weakness of the U.S. economy and a relaxation of the strong dollar policy by the Bush administration. "There is now a realization that there will not be a V-shaped recovery," Sharma said, adding, "economists have been trying to pick a letter, U or L, take your pick."
