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Vol Drops Off As Dollar Gains On Euro

15 Dec 2006

One-week implied volatility on the euro versus the U.S. dollar fell last week to 7.5% from around 9% as the dollar recovered from its stumble in the past month.

One-week implied volatility on the euro versus the U.S. dollar fell last week to 7.5% from around 9% as the dollar recovered from its stumble in the past month. Strong news from U.S. retailers and illiquidity in both options and cash trading also helped the dollar, traders said. Hedge funds were closing out their positions and many stopped trading entirely to tally year-end totals, which caused liquidity to dry up. Hedge funds dominate the bulk of short-dated trades.

In the spot market, the pair returned to the EUR1.32 area from EUR1.33 earlier in the month. "There was a theory for a bit this month that we would replicate what happened a few years ago in this pair and people were definitely positioned long the euro in late November," said one currency options trader. Dealers took profits when the euro hit a record high of EUR1.36 against the dollar at the end of 2004, he explained. "But there has also been a fair amount of spot directionality [already] and hedge funds realized that the market was not going to go up [further]. There was no need to push it up beyond those levels this late in the year," he added.

Thin trading saw dealer accounts trading with each other and buying one-week straddles with strikes at the money and close to EUR1.32. "If you normally rely on clients like hedge funds to determine trades of this type it's definitely more difficult this time of year," said one currency options trader about predicting the future direction of spot.

"Volatility may not go below 7%, but you may see some spot volatility on an intra-day basis," said Andrew Chaveriat, currency strategist at BNP Paribas in New York. Intra-day volatility could be spurred by some corporate accounts coming in to do end-of-the-year hedging, he said.

15 Dec 2006