[SINGAPORE] Hedge funds worldwide look to be favouring the US dollar in the option market as they bet that the currency’s rebound versus most major peers will extend into year-end.
Funds in Europe and Asia have ramped up option trades this week based on the view that currencies such as the euro and yen will weaken against the US dollar, according to traders. Bearish option trades on the euro versus the US dollar expiring by December saw three times more trading volumes than bullish ones on Wednesday (Oct 8), data from the Chicago Mercantile Exchange Group show.
“We have seen hedge funds looking for a tactical play in long US dollars in the short term,” said Mukund Daga, global head of currency options at Barclays Bank, referring to expiries before year-end.
Rising wagers favouring the US dollar may be a sign that weakness in the currency spurred by the US government shutdown and interest-rate cuts from the Federal Reserve may have run its course. That is because losses in other major global currencies like the yen and euro are raising the appeal of the greenback.
The euro is being weighed down by France’s political turmoil, the yen slumped on speculation Japan’s likely new leader may favour slower interest-rate hikes, while the bigger-than-expected rate cut in New Zealand dragged down the local currency on Wednesday.
Hedge funds expressed a bullish view on the US dollar against most Group-of-10 currencies, with the exception of the Australian dollar, Daga said. That’s because the Australian central bank’s relatively hawkish policy is supportive of the local currency.
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They bought vanilla US dollar call options or call spreads against the euro, sterling, yen, and the New Zealand dollar, according to Daga.
A vanilla US dollar call option is a standard contract without any complex features, which increases in value if the greenback rises. A call spread is relatively cheaper and caps the potential for profit should the US dollar rally.
“Most of the US dollar call buying has been in the G-10 majors and the jumps in front-end risk reversals in these currencies are a good indicator of the turn in demand,” said Nathan Swami, Singapore-based head of FX trading for Asia-Pacific at Citigroup A risk reversal compares the price of a call option versus that of a put option.
According to Swami, it’s “still too early to tell if this is a definite sign that the US dollar has bottomed out.”
Thomas Bureau, global co-head of FX option trading at Societe Generale, has a similar view. “The market is not playing yet a strong reversal of the US dollar,” he said. Most market participants were looking at bearish option trades on the US dollar for the year-end, before sentiment reversed this week, he added.
Daga said he has seen tactical buying of longer-term cheaper options that profit from a significant US dollar rally, often referred to by traders as a “tail risk.”
The Bloomberg Dollar Spot Index extended gains to its highest since Aug 5 on Thursday. The gauge has risen more than 2 per cent since falling to a year-to-date low last month.
“The overarching theme is that the confidence in fiat currencies is extremely low, but among the fiat US dollars are still a better hold,” Daga said. BLOOMBERG
