Billions in currency options set between $1.04 and $1.07 stand between the dollar and a push past this year's highs against the euro, according to traders. Reuters polling and other measures of expectations on interest rates suggest an up to 80 percent probability of a US Federal Reserve hike next month, while most investors expect the European Central Bank to do the opposite.
That divergence has backed a 5 percent drop in the euro against the dollar over the past month, to the relief of the big currency trading banks who have been expecting all year the greenback to rise to parity with the euro. This week has proved stickier, however, and dealers point to derivatives pricing as evidence of reluctance or inability of investors to make the bets that would push the dollar back to peaks of $1.0450 seen in March and April.
Data from US securities clearing house DTCC, shows some $12 billion in options with strike prices around $1.05, $1.06 and $1.07 maturing on December 18. "A lot of people have been putting on downside option structures and the market has been aware of them for a while," said a dealer with one international bank in London.
"That is one of the big reasons why you are seeing a lot of stickiness around these levels and it may be hard to push through." Demand has risen for options guarding against price volatility - known as vol in market jargon - and some say that stems chiefly from players hedging to safeguard already winning positions in the euro from big moves at year-end. Notably, there are just a handful of strikes, worth less than $5 billion providing for the euro hitting parity with the dollar on December 18.
The bulk of the options market - worth several hundred billion dollars a day and widely used by traders and hedge funds as a way of speculating on currency moves or hedging - is conducted via over-the-counter transactions. The DTCC numbers also do not account for the wide range of "exotic" contracts, priced and tailored to a particular client's specification. "There is certainly demand for downside option strikes in euro/dollar but I wouldn't say I have seen hugely increased demand," said the head of options at one London brokerage.
Richard Benson, co-head of portfolio investments with institutional currency managers Millennium Global, said he expected the euro to grind higher and that a number of tailored strikes set just below the March high of $1.0457 would serve as a magnet for trade into the end of the year. "Part of the downside action is because there is a general reluctance to take position in the spot," said a trader with one North American bank, saying he saw plenty of strikes in the $1.05-$1.06 area, but little around parity. "Macro funds have been burnt in the short euro/long dollar trade while real money investors have done well and will look to preserve their profit/loss accounts into the year end. So that leaves you the option route, but we think it will be a low volume/low position trade."
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