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Hedge funds increase options bets on yen gains, as the yen hits year-to-date highs

2024-09-16

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Hedge funds have increased their options bets on the yen's rise in the foreign exchange market, expecting the currency to continue its rally as the world's best performing currency this quarter.

The dollar closed down 0.65% against the yen at 140.87 on Friday (September 13), and hit a low of 140.28 during the session. In early Asian trading on Monday (September 16), the dollar hovered at a low against the yen, currently trading around 140.69.

At present, hedge funds are making bullish bets on the yen, including currencies such as the Australian dollar and the Swiss franc, and the relevant traders asked not to be named.

Signs that the Bank of Japan may raise interest rates further - although it is unlikely to take action at this week's meeting - have helped the yen rise by about 14% against the dollar since the end of June. Expectations that the Federal Reserve may cut interest rates have also driven the move, while quickly reducing short positions in the yen.

Nathan Swami, head of foreign exchange trading in Asia Pacific at Citibank, said he saw demand from leveraged investors for options on the decline of various currencies against the yen. These operations include volatility neutral strategies such as knock-out and knock-out, as well as puts or put spreads that pay market makers for volatility.

This week could be a key moment for these options trades, with the Bank of Japan set to announce its policy decision on Friday (September 20), following an expected mid-week rate cut by the Federal Reserve. Recent comments from some Bank of Japan board members suggest that Japan could still raise rates in the future despite the policy rate being raised to 0.25% in July.

If the Bank of Japan does not rule out another 25 basis point rate hike this year this week, the yen could get a boost as swaps markets lag pricing, with only a 32% chance of another rate hike being priced in.

"Assuming the Bank of Japan does not rule out another rate hike before the end of the year, we expect USD/JPY to continue moving towards 140 in 3-6 months," said Jane Foley, head of FX strategy at ABN Amro.

Other strategists expect USD/JPY to fall further by the end of the year, possibly even hitting 135.

Despite the yen's gains, its daily volatility may keep some hedge funds on the sidelines for now. Although the currency also hit an eight-month high on Wednesday, options trading volume at the Depository Trust & Clearing Corporation (DTCC) that day was a third lower than the five-day average.

"We were surprised by the lack of leverage participation from the fast money community," said Ruchir Sharma, global head of FX options trading at Nomura Securities.

Sharma believes hedge funds may be staying on the sidelines for now because of the high cost of downside options on the currency pair.

As of the end of trading last Thursday, investors were paying a 1.81% premium to hedge downside risk on USD/JPY over the next month. Sharma believes that to attract more hedge funds into yen options trading, its realized volatility needs to fall.

This in turn will affect the implied volatility of the yen. "Recent data shows that a higher realized volatility base has kept implied volatility supported," said Swami of Citibank.

Lower implied volatility is good for hedge funds because it is a factor in the market maker's pricing formula. A drop in implied volatility will help reduce the cost of buying options, making it a more attractive betting option for traders.

The above information is provided by special analysts and is for reference only. CM Trade does not guarantee the accuracy, timeliness and completeness of the information content, so you should not place too much reliance on the information provided. CM Trade is not a company that provides financial advice, and only provides services of the nature of execution of orders. Readers are advised to seek relevant investment advice on their own. Please see our full disclaimer.

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Hedge funds increase options bets on yen gains, as the yen hits year-to-date highs

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