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Weakening Dollar Fears Prompt Euro Call Buying

One-month euro/U.S. dollar implied volatility rose to 14% Wednesday from 11.5% the day before the attack on the World Trade Center in New York. Demand for euro calls/dollar puts and uncertainty drove the jump in volatility over how a U.S. retaliation to the terrorist attacks would impact an already weakening dollar. Investment banks were the most active, buying one-week euro calls/dollar puts last week as the one-month risk reversal moved further in favor of euro calls. The options typically had strikes around USD0.95, when spot was trading at around USD0.93. Traders say they were buying euro calls and selling dollar puts for protection rather than taking profits. "Many are staying out because of the tragic events. Nobody really has a handle on where the dollar is going to go. A lot will depend on the U.S. equity markets and interest rates," one trader commented.

Paul Podolsky, a foreign exchange strategist at FleetBoston Financial, predicted more volatility in the dollar over the next month. "It's impossible to price national security," Podolsky said. He added that while traders are able to anticipate the odds in economics, it's nearly impossible to adjust to what the risk might be if the U.S. military goes into action. Podolsky said, however, that even the slightest news of U.S. military intervention could see the dollar strengthen by as much as 2% in one day.

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