Banks sold off short-dated U.S. dollar put and call options against all the major currencies at the end of last week. The move was sparked by Federal Reserve chairman Ben Bernanke's testimony to Congress Wednesday morning, which the market saw as more doveish than it had been anticipating.
Ahead of his comments, players had been buying up any short-dated options with a range of strikes to try and capture volatility on dollar crosses. "Since the start of the week everyone was trying to buy options against every major dollar pair," said one New York trader. "People bid up options through [Wednesday] to cover the event. Now the big event is over."
New York traders said last-minute option buying sent implied volatilities skyrocketing just before Bernanke's speech. Overnight EUR/USD implied volatility spiked to 16% in London trading Wednesday morning from 9% last week. But, by early afternoon New York time, overnight implied vol had settled back to about 8.5%. In the spot market, the greenback rallied to several-month highs against the euro and yen Tuesday and dropped back off Wednesday. EUR/USD spot traded at USD1.26 Wednesday afternoon from USD1.24 Tuesday. "Today's move takes spot back into the middle of its recent range," said one trader, noting now the big event of the month is over, implied vol will likely remain low and spot range-bound.
Greg Anderson, senior fx strategist at ABN AMRO in Chicago, said although Bernanke's comments were seen by many as dovish, he thought they were fairly balanced. "The market was ripe for a reversal," he said, referring to the dollar rally and option buying earlier in the week. But he noted, "That made it overplay what actually happened."