(Bloomberg) -- Traders in dollar-yen options are changing their strategy going into an expected Bank of Japan interest-rate increase Friday now that US President Donald Trump’s inauguration is over.
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Before this week, investors’ bias had been to buy downside put options that gain in value if dollar-yen falls further, as expectations for a BOJ hike mounted. Now that’s almost fully priced in, they’ve turned their attention to a strategy that benefits if the currency pair trades in a tight range after the policy decision.
Dollar-yen’s implied volatility, or vol, a measure of the expected future movement, has been under noticeable pressure the last few days. It fell for a sixth day Thursday to its lowest since July.
“Since the inauguration, vol selling has been the theme as uncertainty around if, and when, Trump would carry through his tariff threat has grown,” said Graham Smallshaw, senior FX spot trader at Nomura Singapore Ltd.
“Pre-inauguration, clients were mostly looking at outright downside cross-yen and downside dollar-yen plays in the option space, mostly as protection for a potential risk-off equity trade on potential Trump tariffs,” Smallshaw said. This strategy also coincided with a growing belief that the BOJ would hike this week, he said.
At the same time, the premium to hedge dollar-yen’s downside over the next month, compared to upside, has fallen, signaling less interest in the pair declining further near-term.
Swaps pricing is indicating that a BOJ hike of 25 basis points is nearly a forgone conclusion, following hawkish rhetoric from the central bank last week. With that priced in, dollar-yen’s downward momentum has stalled. So far this week it’s been unable to breach support around its 50-day moving average.
Dovish Hike
This means investors looking for dollar-yen to fall further on a rate hike may end up being disappointed.
“From a markets point of view, the risk is a dovish hike as this may suggest that dollar-yen’s move lower may be more constrained,” Christopher Wong, an FX strategist at Oversea-Chinese Banking Corp. in Singapore, wrote in client note this week.
With markets almost fully pricing in a second quarter-point increase later this year, a dovish hike would leave the currency pair vulnerable to move higher. That possibility seems to be something a few funds are exploring so far.