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Foreign Exchange

Yen volatility rises as BOJ intervention threat heightens

Moves by the Swiss National Bank to curb the recent appreciation of the Swiss franc have heightened the risk that the Bank of Japan might soon be forced to intervene in the FX markets to weaken its own currency. As a result, dollar-yen volatilities remained elevated on Wednesday as investors piled on bets, with the yen likely to breach levels below 77.00.

One-month implied dollar-yen volatility were trading at around 10.85%, compared with 8.6% two-weeks ago, as investors looked to hedge the potential of intervention from the Bank of Japan to buy dollars. High levels of implied volatility prompted investors to seek cheaper structures to express a yen-weakening view, with strong demand for dollar-call knock-ins, traders say.

Based off a spot rate of 77.20, investors have been looking to buy dollar calls at strikes around 78.50, which only become active if the yen first appreciates to 76.00. So-called knock-in structures cost investors around eight basis points, compared with 30bps for the vanilla dollar call at 78.50.

“Dollar-yen is not moving but there is a lot of potential for it to do so,” says Philippe Zebouni, an FX options trader at HBSC in Hong Kong. “With implied vols high, the exotic structures with additional optionality are a cost-effective way to bet on intervention.”

Other options traders report a lot of buying of top-side gamma, which has seen heightened buying of out-of-the-money dollar calls/yen puts. While traders have shown an interest in buying short-dated calls, the options market still remains skewed towards the buying of dollar puts.

In a reversal in favour of dollar puts, one-week risk was put at 1.5%, traders say, the highest level since September 15 2010, when the Bank of Japan last intervened to weaken the Japanese currency. Still, that level is well below the 8.5% seen at the height of the financial crisis.

The Bank of Japan could loosen monetary policy at a policy meeting later this week, or expand its asset-buying scheme, which currently stands at ¥10 trillion ($129 billion).

“Intervention is likely at some point but I don’t think we are at a crisis point quite yet,” said Simon Smollet, an options strategist at Calyon.

Smollet sees volatility trading between 10% and 12% in the short term. One-week implied volatility was trading around 13.50 % on Wednesday, compared with 11.95% on Monday, while the one-month was quoted at 11%, versus 10.30% earlier in the week.

The exercise of barrier options set below the record low level of the dollar could spark a dollar sell-off, analysts say. However, concern should be mitigated by the fact that the existence of such barriers is “normal” when currency pairs approach record trading levels, Smollet says.

Japan’s finance minister, Yoshihiko Noda, said on Wednesday that the yen’s rise does not reflect the country’s economic fundamentals and that he will continue to watch market moves closely.

Earlier, the Swiss franc fell sharply against the euro after Switzerland's central bank cut interest rates. Implied volatilities softened with one-month euro/franc vols trading at 17.60%, versus 18.70% beforehand.

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