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Derivatives

Yen Uptick Prompts Call Buying

Traders in the foreign exchange markets were positioning for major yen appreciation last week after U.S. Treasury secretary Henry Paulson said he is watching the yen very carefully.

Traders in the foreign exchange markets were positioning for major yen appreciation last week after U.S. Treasury secretary Henry Paulson said he is watching the yen very carefully. Players took the comments to be a signal that foreign exchange issues will be a key part of the agenda at the G7 summit in Germany this weekend. Traders noted a sharp risk reversal move to favor yen calls in the U.S. dollar/yen. There was no real consensus, however, as to where the pair would settle and strikes were within a larger-than-usual range.

One-month dollar/yen implied volatility shot up to 8% from about 6.9% a week earlier. The yen was at JPY120.842 against the dollar Thursday.

Investors of all kinds were buying short-term options up to one month on yen crosses to capture volatility after the yen gained in the spot market, to settle at JPY121.70 on Wednesday afternoon. Others were buying one-week dollar/yen calls with downside strikes from JPY121 down to below JPY110, as well as around JPY234 and JPY233 against the British pound.

One trader reported pricing a dollar/yen nine-month call with a JPY102 strike, which he said signals that many fx players are positioning for a major unwind in the dollar/yen carry trade; a move that would drive the yen higher.

The risk reversal rate for one-month options on the yen was at 0.675% last week, after shrinking to minus 0.2% on Jan. 23, the smallest premium since Oct. 16. A greater value indicates increased demand for yen puts over yen calls

"The dollar/yen risk reversal levels reached an extreme,'' according to Naomi Fink, a senior currency strategist at BNP Paribas in New York. BNP predicts a yen advance to JPY118 against the dollar by March 31.

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