One-month euro/dollar implied volatility rebounded to 8.2% from 7.4% on Wednesday following comments from Federal Reserve Chairman Alan Greenspan suggesting rates are on hold. Traders said implied vol had been falling steadily lower because euro/dollar had been trading in a narrow range in the spot market, but Greenspan's comments caused the dollar to weaken and drove vol higher. Common trades saw both investors and hedgers buying euro calls/dollar puts struck at USD0.89-0.90 with spot trading at USD0.882 when the options went through.
Most of the trades had one-month or one-week maturities, traders said, adding that implied volatility in the long-end of the curve did not rebound as much as in the short-end. In March, 12-month implied vol was at 9.2%, dipping to fractionally below 9% at the beginning of the week, and then rising to 9.3%. The difference between the short-end and long-end is signaling that the rebound in the euro has not translated into a major shift in market perception of the longer-term direction of the currency, an analyst said.
"The Fed is leaving the door open for events to bounce implied volatility around," said Bob Gay, global head of fixed income at Commerzbank Securities. He explained that Greenspan's comments allow for other factors, such as events in the Middle East, to affect currencies since there is no clear indication of what will happen to interest rates.
A trader said that speculators were leading the charge by purchasing euro calls/dollar puts, and corporates were hedging in anticipation that volatility will rise even higher. "Vol is still relatively cheap," he said. In the past few weeks implied vol has been at its lowest levels since September 1996 when it got as low as 6.5% for one-month dollar/Deutsche mark, according to Ian Stannard, a foreign exchange strategist at BNP Paribas.
The rally in the euro, however, may run out of steam as speculators take profits if too many people get on the same side of the trade, prematurely bidding up the euro, traders said.