Reuters: US Dollar Report: Forex options less bearish on euro, ECB action eyed

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Forex options less bearish on euro, ECB action eyed Aug 30th 2012, 20:49 By Julie Haviv NEW YORK | Thu Aug 30, 2012 4:49pm EDT NEW YORK Aug 30 (Reuters) - Expectations that the European Central Bank will take action to reel in the region's more than two-year-old debt crisis have been bullish for the euro versus the U.S. dollar, but some in the options market are positioning for disappointment. The euro has gained 1.6 percent against the greenback in August, largely a reflection of optimism that the ECB will unveil a plan, perhaps as soon as its next meeting on Sept. 6, to bring down the high borrowing costs of Italy and Spain, the euro zone's third- and fourth-largest economies, respectively. Implied volatility, or "vol", a measure of expected price swings and a gauge of option pricing, on six-month euro/dollar options traded at 10.75 percent on Thursday, down from 11.20 percent at the beginning of August and sharply lower than 13.40 percent in early June. Steven Englander, head of G10 strategy at CitiFX, a division of Citigroup in New York, said the unit holds a long position in six-month euro/dollar options. "Our premise is that the good news cycle for the euro is close to peaking," he said. "How fast it declines is less certain so we feel that given extraordinarily low implied volatility, the six-month tenor for euro/dollar puts is attractive in terms of fundamentals and cost." Risk reversals, a broad gauge of currency market sentiment, show that options investors are still seeking protection against the euro's depreciation, but demand has diminished. Indeed, risk reversals remain biased to puts, or the right to sell euros, with six-month reversals trading at 2.05 percent on Thursday. That is down from 2.25 percent a week earlier and 2.35 percent at the beginning of the month. To some, this decline is a bullish sign. "A shift like this in option markets is generally a relatively solid signal of a shift in currency direction," said Camilla Sutton, chief currency strategist at Scotiabank in Toronto. "For now it still implies that as far as the option market goes, the preference is to cover short euro positions and support a stronger euro in the near-term," she said. Three-month reversals, widely used by hedge funds, traded at 1.70 percent on Thursday, down from 1.80 percent a week ago and 2 percent early August. The euro, last trading at $1.2498, has rebounded smartly from late July's two-year low of $1.2040. ECB President Mario Draghi ignited the rally late last month when he said the central bank would do what was necessary to preserve the currency. October $1.18 and $1.20 euro puts were actively traded this week, according to Matthew Schilling, a commodities broker at RJO Futures in Chicago. Investors who buy these puts expect the euro to fall below those price levels before they expire on October 5. "There is still low interest on October calls and with the euro trading around $1.25 that tells me that we still have some more downside next month," he said. EURO OBSTACLES ABOUND Indeed, the euro still faces plenty of headwinds, with a dismal economic landscape and ongoing concerns about a possible Greek exit from the euro zone likely to limit the currency's upside. After the ECB monetary policy meeting next week, the German Constitutional Court is expected to rule on the euro zone rescue fund on Sept. 12. Also, European Union finance ministers meet on Sept. 14 and a report on Greece by its international lenders is due by early October. "The main factor reining in euro/dollar volatility is the looming event risk for monetary policy on both sides of the Atlantic," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington D.C. "On the one hand, the specter of an increasingly easier Fed has put a near-term ceiling above the dollar," he said. "But on the other hand, investors are also mindful that European officials do not have the best track record when it comes to meeting market expectations." Fed Chairman Ben Bernanke will address an annual symposium in Jackson Hole, Wyoming, on Friday. It was at this same event in 2010 that Bernanke laid the groundwork for a second round of bond buying, called quantitative easing, to bolster the economy. "I would say the drop in vols prior to a dangerous decision time indicates the markets can't figure out how to play it," said Andrew Busch, global currency & public policy strategist at BMO Capital Markets in Chicago. "Traders have clearly cut back significantly on the 'world coming to an end' trades, but don't really want to go all in on the 'world is going to be great' trade just yet," he said. Link this Share this Digg this Email Reprints

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