* Some hedge funds betting SNB's cap will be challenged
* One-month risk reversals, vols have jumped this week
* Sizeable stop-loss orders cited below 1.20 francs
By Anirban Nag
LONDON, May 25 Investors are increasing bets the Swiss National Bank will be unable to defend the franc's cap against the euro as the common currency comes under pressure on the prospect of Greece leaving the euro zone.
The action is in the options market, where the one-month premium in favour of Swiss franc calls - bets the franc will rise against the euro - has risen to its highest since August 2011, a month before the SNB introduced a cap of 1.20 francs on the currency pair.
The SNB imposed the cap in September 2011 after the safe-haven franc hit record highs last year and raised concerns about deflation and a sharp slowdown in the Swiss economy. Despite a brief breach of the cap in early April, the SNB has said it will defend it with all its might.
But with the euro falling sharply against other major currencies since Greek voters punished parties supporting the country's international bailout in a May 6 election, it has become tougher for the SNB to defend the peg.
This, and the fact it has already been breached once, has emboldened some investors and speculators to challenge the central bank, particularly with Greece facing a second election on June 17, analysts said.
"Some hedge funds are betting that as the euro zone situation deteriorates, the SNB's peg will be breached," said Geoff Kendrick, currency strategist at Nomura, who expects the SNB to defend the peg at all costs.
Reflecting those bets, one-month implied volatility, a gauge of option prices and expectations of future price swings, has risen to around 5.75 percent from around 3.4 percent at the end of last week, according to Reuters data.
Risk-reversals, a measure of the relative demand for options on the euro rising or falling against the franc, are showing a st rong bias for more euro weakness and edging back to levels seen just before the SNB introduced the floor.
The one-month euro/Swiss franc 25-delta risk reversals are showing a premium of around 3.4 vols in favour of a weaker euro. It was all but flat, suggesting investors thought the cap would hold, as recently as early May.
HEADACHE FOR THE SNB
This month the euro has fallen sharply against the dollar , sliding to a near two-year low. It has dropped to its lowest since February against the safe-haven yen and is holding just above a 3-1/2 year low against the British pound .
But the euro has barely moved against the franc, triggering speculation that the SNB has been intervening by buying euros to ward off any upward pressure on the Swiss currency.
That has kept the euro around 1.2010 francs for much of May, before it jumped briefly to 1.20769 francs on Thursday, its highest since mid-March. The rise proved fleeting and the euro weakened to trade around 1.2016 on Friday.
In the run-up to the Greek vote, the leftist SYRIZA party, which opposes the bailout terms, is ahead in the polls, keeping markets on edge.
Worries about a possible Greek euro exit and the risk of contagion to other highly-indebted states in the currency bloc, have driven investors to perceived safe havens such as the dollar, the yen and even the Danish crown, which is pegged to the euro.
While the Danish central bank cut interest rates on Thursday to curb the crown and keep it within its permitted trading band, the SNB has so far shied away from raising the cap, despite calls from exporters and politicians to do so.
Citi currency strategist Valentin Marinov said that with the uncertainty about Greece and the SNB seemingly unlikely to lift the euro/Swiss franc floor for now, the common currency could come under pressure.
"This could also lead to further upside pressure on FX implied volatility and keep risk reversals bid."
He said there were sizeable orders to sell the euro just below 1.2000 franc, highlighting the risk of a sharp drop against the franc if the peg were temporarily breached.
Morgan Stanley said in a note on Friday that despite speculation the SNB might take steps to weaken the franc in the next few days, it expected the euro to break below the floor in the third quarter of this year.