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Derivatives

Vol Selling Sets New Lows

Hedge funds started selling long- as well as short-dated U.S. dollar/yen volatility last week, causing implied volatility across maturities to set all-time lows.

Hedge funds started selling long- as well as short-dated U.S. dollar/yen volatility last week, causing implied volatility across maturities to set all-time lows. One-year USD/JPY implied vol traded at 7.325% Thursday, while two-year implied vol traded at 7.35% and three-year at 7.4%. Spot remained unchanged at JPY118.

Traders said the most popular trades were selling two- to three-year at-the-money straddles. The longer-dated plays were the latest development in a vol selling trend that has been going on for months across major currency pairs. Range-bound spot and low historic volatility levels have contributed to all kinds of players selling volatility and causing implied vols across currencies to plummet to record lows.

"We need news or a big event for spot to break free of range and for interest in the options market to come back," said one London trader. "A lack of volatility in G3 currencies is encouraging investors to move out the yield curve and reach for high-yield currencies."

A variety of players turned to three- to six-month one-by-one and one-by-two put spreads on emerging market currencies last week. Popular pair trades included U.S. dollar/Turkish lira, U.S. dollar/Mexican peso and Brazilian real/yen. With USD/TRY spot at TRY1.44, hedge funds were buying dollar puts from at-the-money to TRY1.47 and selling dollar puts from at-the-money to TRY1.40 to take advantage of any movement in the currency.

Peter Frank, director in fx strategy at ABN AMRO in London, said rising interest rates in Japan or easing of U.S. rates could cause a dramatic turnaround in volatilities. He expects a reversal by early next year.

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