Hedge funds were piling into short-dated options on yen crosses last week after the global equity market sell-off spread to the yen carry trade. "People were piling into those trades carelessly," said one fx options trader, referring to the popular strategy where investors borrow low-yielding yen to invest in higher-yielding currencies. "Now the story is different and everyone is buying volatility to protect themselves."
One-month U.S. dollar/yen implied volatility spiked to a high of 8.8% in New York trading Tuesday from 6.5% the week before, and one-year implied volatility rose to 7.6% Tuesday from 6.5% over the same period. On Thursday, one-month implied vol was at 8% and one-year implied vol was at 7.25%. In the spot market, U.S. dollar/yen plunged to JPY117.95 Tuesday from JPY121.4 Monday. It was at JPY118.2 Thursday morning.
London traders reported strong demand for downside yen calls and risk reversals with strikes around JPY110. The premium for one- to three-month yen calls rose to 1.4 vol points Thursday from 0.8 vols last week, while the premium for longer-dated calls rose to 1.4 vols from 1.2 vols. "All yen calls are trading at a big premium, but the acceleration is higher on the front," said one Citigroup trader. "It's higher because of the move [in volatility], but people have not made up their minds yet whether it will be sustained."
Naomi Fink, fx strategist at BNP Paribas in New York, said last week was likely a "preview of what carry trade unwinding could look like," rather than "carry trade unwinding in full swing." "The stock markets have stabilized, so maybe it's not the first domino to fall, but it may sensitize market players to the risks taken," she added.
