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Derivatives

Dollar Strength, Nuclear Fear Rattle Yen

A flip away from recent bearishness on the U.S. economy combined with concerns over North Korea's underground nuclear test weighed on the yen last week.

A flip away from recent bearishness on the U.S. economy combined with concerns over North Korea's underground nuclear test weighed on the yen last week. The U.S. dollar climbed toward the JPY120 key psychological barrier that hasn't been reached since late last year. Implied dollar/yen volatility, however, remained subdued near 12 month lows: one-year implied vol was at 7.76% Wednesday.

Low volatility meant upside strikes were discounted and option players were buying up dollar calls and yen puts across short-term tenors from one week to one month. Investors were buying in-the-money straddles to capture any potential move in the currency, as well as dollar calls with strikes at JPY120 and JPY125. Traders reported strikes were much more bullish on the dollar versus the yen than they have been in the past year. One noted interest in one-year dollar calls with a JPY130 strike.

Investors were skittish on Asia in general following North Korea's nuclear test claims and at the same time the dollar was experiencing a rally, which began with the release of U.S. payroll-data revisions at the end of the previous week. "From a U.S. point of view, this is not only a rates story, but to a degree a market story on investors finally being more realistic on what the Fed might do," said Rebecca Patterson, head fx strategist at JPMorgan in New York. In a BNP Paribas report, strategists noted generic dollar strength versus the major currencies increases the probability that the dollar is in the early stages of a powerful fourth-quarter rally. Patterson said she expects the JPY120 barrier to be broken, but did not give a time frame for this.

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