Forex options shift in yen keeps moving in dollar's favor

NEW YORK, May 23 (Reuters) - Investors have ducked for cover in the Japanese yen during the latest chapter of Europe’s debt crisis, but the options market views the U.S. dollar as a safer bet.

The dollar and yen both benefit from safe-haven flows amid Europe’s crisis. But, until this year, investors historically tended to position for dollar weakness against the yen, based on risk reversals, a broad currency sentiment indicator.

However, three-month dollar/yen risk reversals , began tilting pro-dollar early this year and have shown an even more solid shift toward the greenback this month.

Adding momentum, one-year risk reversals recently switched to dollar calls, or the right to buy dollars, for the first time since at least late 2006, according to Thomson Reuters data.

This indicates pro-dollar sentiment broadening from the hedge fund sector that largely drives short term risk reversals, since longer ones are often led by hedging activity.

“This could be interpreted as meaning that the market places more value in the dollar as a safe haven than the yen,” said John Hopkinson, head of FX quantitative and options research at BofA Merrill Lynch in New York.

“Traditionally the yen’s role as a funding currency meant it tended to outperform in risk off periods, but the market has apparently decided that the balance of risks favors the dollar.”

The switch also comes amid erosion of traditional yen strengths, such as decades of Japan trade surpluses, now turned to deficits.

Another reason is the narrowing of the yield differential between U.S. Treasuries and Japanese government bonds, erasing the appeal of carry trades in which investors borrowed yen and bought dollars.

“With the carry trade no longer in play a big source of demand for dollar puts has been removed from the equation,” said Rob Bogucki, head of FX trading, Americas, at Barclays in New York.

Though the carry trade would normally be negative for a funding currency like the yen, it also created demand for dollar puts as investors hedged those positions.

Nevertheless, the trend in risk reversals reflects a “medium to long term view that the dollar will outperform the yen both technically and fundamentally,” said Dean Popplewell, chief currency strategist at OANDA in Toronto.

“Buying call options in a spot market that has a bias to trade risk averse, option traders are buying insurance if and when the spot market turns in the dollar’s favor.”

The dollar, last at 79.24 yen, is down 5.9 percent from a mid-March peak, slicing its year-to-date gain to 3 percent.

Also impacting dollar/yen options are Japanese exporters, who in the past actively hedged their large supply of dollars.

“Japanese exporters are no longer running a big surplus,” Barclays’ Bogucki said. “If they are no longer awash in a sea of dollars, they no longer need to buy puts to protect it.”


Vassilis Dagioglu, managing director at Mellon Capital in San Francisco, said Mellon Capital recently trimmed their long yen position despite remaining significantly long due to its safe-haven status.

“We like the yen because it is a form of risk control and the best way to navigate the many macro factors and events going on right now,” he said. “Uncertainty should continue to favor the yen with no resolution in sight to the euro zone debt crisis and Greece’s future in the euro zone uncertain.”

Dagioglu is part of a team that manages nearly $15 billion in asset allocation strategies.

Implied volatility, or “vol,” a measure of the options market’s expectations of price movements, on three-month dollar/yen options traded at 9.45 percent, down from a peak of 11.25 percent in mid-March.

“We think dollar/yen will stabilize around 80 for a while and vol has come down notably from the peak of excitement in February-March,” said Jens Nordvig, global head of fx strategy at Nomura Securities in New York. “We think some upmove in dollar/yen is possible, perhaps toward 85 by year-end.”