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Derivatives

Conflicting Directional Trades Push Up Dollar/Yen Vol

Implied volatility on the U.S. dollar/Japanese yen currency pair jumped close to six-month highs last week, driven by market players' uncertainty about the direction of the pair.

Implied volatility on the U.S. dollar/Japanese yen currency pair jumped close to six-month highs last week, driven by market players' uncertainty about the direction of the pair. As a result, traders bought out-of-the-money options on both the yen and dollar. By Wednesday, the generally stable one-year implied volatility level had jumped to 9.85% from 9.55% on Monday and one-month implied volatility rose to 11.98% from 11.62%. A corresponding move in the spot market, which saw the dollar strengthen against the yen to JPY114, further fuelled the rise in implied vol.

"There's a lot of uncertainty over direction on dollar/yen," noted one trader. Traders reported market players buying one-year yen puts struck at JPY125, but also noted other players were purchasing one-year dollar puts struck at JPY85. "This is the first time in a while we have seen [traders] buying puts on the yen downside at the JPY125 level," noted one trader, who said fears that the Nikkei could break through the 10,000 barrier and damage the Japanese recovery were driving the trades. The majority of players active in buying options were hedge funds, added the trader.

Nick Parsons, a currency strategist at Commerzbank in London, explained data from the Commodities Futures Trading Commission showed the market has significantly misjudged the direction of dollar/yen several times since February, which could be one reason why there is interest in buying cheap out-of-the-money options. "Buying these out-of-the-money options is the equivalent to buying lottery tickets," added Parsons.

USD/JPY Spot & One-Month Implied Volatility

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Source: JPMorgan

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