FOREX-Euro cedes early gains as FX derivative bets weigh

* Graphic: World FX rates in 2018

LONDON, Dec 21 (Reuters) - The euro reversed its earlier gains and weakened on Friday after traders failed to push the single currency above a key market level and large derivative bets also pulled the dollar higher.

With liquidity already thinning going into the year-end holiday period, large currency options are having an outsized impact on the cash markets.

Large options around the $1.15 levels pulled the euro 0.2 percent lower at $1.1423 and nearly half a percent below the day’s high of $1.1474 in early London trading.

The euro’s sudden weakness boosted the dollar which gained 0.3 percent against a basket of its rivals at 96.58. Despite, the dollar’s bounce, the greenback remained on track for its biggest weekly drop in four months.

“Some large currency options around the $1.15 levels are expiring today and that is pulling the euro lower as banks are actively looking to defend that level,” said a trader at a European Bank in London.

The magnitude of options in currencies can be a big factor for trading as banks selling such products would actively try to prevent the market from triggering those derivatives as it would fuel broader volatility as traders rush to cover their bets.

About $6 billion of currency options are set to expire between $1.1450-1.1500 levels later in the day, according to Refinitiv data, far more than what has been traded in recent months.

Even technical charts are proving to be a significant headwind for the euro.

The single currency has failed to break above a 100-day moving average after falling below it in September. On two occasions in mid-October and this week, the euro has tested those levels and fallen back. That level is at $1.14844 on Friday.

But despite the dollar’s bounce, markets remained wary of pushing the greenback higher as the threat of a U.S. government shutdown and lower bond yields on the back of concerns of slowing economic growth weighed on sentiment.

“I think the markets are focusing more now on U.S. economy-specific risk rather than global economy risks and that is weighing on the dollar,” said Thu Lan Nguyen, an FX strategist at Commerzbank in Frankfurt.

The safe-haven Japanese yen benefited from the nervous sentiment, steadying broadly against the dollar to 111.21 yen.

Adding to pressure on the dollar was news that U.S. President Donald Trump has refused to sign legislation to fund the U.S. government unless he gets money for a border wall with Mexico, risking a partial federal shutdown on Saturday.

The pound was flat at $1.2661. (Reporting by Saikat Chatterjee; Editing by Kevin Liffey and Jon Boyle)