Reuters: US Dollar Report: Forex options less optimistic on dollar as Fed looms

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Forex options less optimistic on dollar as Fed looms Sep 12th 2012, 20:09 By Julie Haviv NEW YORK, Sept 12 | Wed Sep 12, 2012 4:09pm EDT NEW YORK, Sept 12 (Reuters) - Expectations for more U.S. stimulus and diminished fears of the euro zone debt crisis has options investors souring on the dollar in favor of the euro. The euro hit a four-month high against the greenback on Wednesday, bolstered by hopes that the euro zone's recent efforts to address its crisis will bear fruit, and that the U.S. Federal Reserve will buy more bonds, seen as a dollar negative. Risk reversals, a broad gauge of currency market sentiment, showed options investors are less enthusiastic on the dollar than they have been for nearly two years, and are seeking scant protection against the single currency's depreciation. The dollar's upside will be limited if the Fed announces a third round of bond buying, called quantitative easing, at the conclusion of its two-day meeting on Thursday. Bond purchases are tantamount to printing money and dilute the value of the dollar. The single currency has risen more than 7 percent since it hit a two-year low of around $1.2040 in July, boosted after European Central Bank President Mario Draghi pledged to do whatever it takes to preserve the currency. Before that, investors were betting heavily against the euro as the region's debt crisis worsened, engulfing larger economies including Italy and Spain. The euro still faces plenty of headwinds, with a dismal economic landscape and ongoing concerns about a Greek exit from the euro zone. While three-month reversals remain biased to puts - the right to sell euros - they traded as low as 1.250 percent on Wednesday, the lowest since mid-October 2010. That means the collective market is less aligned against the euro than it has in recent months. That is a significant improvement from Aug. 14 when it was at 1.950 percent and 2012's peak on May 21 at 3.575 percent. "In terms of option flows, we feel that the market is seeing the euro/dollar going higher," said Olivier Korber, derivatives strategist at Societe Generale in Paris. "We are seeing sellers of risk reversals (selling euro puts, buying euro calls)." "A risk-on picture, optimism ahead of the Fed and a higher euro," Korber said, have contributed to the change in option flows. Furthermore, implied volatility, or "vol", on three-month euro/dollar options, a measure of expected price swings and a gauge of options pricing, fell as low as 8.36 percent on Wednesday, the lowest since mid-December 2007. This means investors expect less volatility, and therefore less reason to hedge against price fluctations. Lisa Mears O'Conner, managing director, alternative global macro strategies, at Mellon Capital in San Francisco, is negative on both the dollar and the euro. "The low vol in the options market may be an opportunity for those investors who want to short the euro due to the weak fundamentals - they can buy puts more cheaply right now," she said. The euro climbed to $1.2936 on Wednesday, its highest level since mid-May, after Germany's Constitutional Court approved the euro zone's new rescue fund and budget pact, mitigating concerns about the region's debt crisis. O'Conner, who oversees $2.5 billion in assets, said risk reversals are closer to fair value now than the middle of July. "It shows less demand for puts, perhaps less of a need to hedge or perceived need to hedge," she said. "This may be an opportunity for contrarian investors to buy puts." The euro last traded at $1.2894, up 0.3 percent on Wednesday. "The euro is less risky than two months ago and 'tail risk' has been substantially removed," said Axel Merk, president and chief investment officer at Merk Investments and manager of the Merk Funds in Palo Alto, California. "In our flagship hard currency fund, we have been rebuilding our euro position ever since ECB President Mario Draghi's press conference after its monthly meeting in early August," he said. Merk, who oversees $600 million in assets, said he is negative on the dollar headed into Thursday's Fed announcement. "Euro/dollar implied volatility has lead us to re-enforce our positive view," he said. Link this Share this Digg this Email Reprints

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