Nervousness has gripped the market over the last few days as vols got paid following a bout of risk aversion. This started on Friday, following the Japanese earthquake, but the real sharp move happened on Monday/Tuesday following the drop in equities: The Nikkei went into a freefall on Tuesday and FX implied vols picked up across the board, but especially in the JPY products. Tuesday’s squeeze saw the real supply disappear as sellers started to flee and the market was caught short and scrambled for cover, ripping through the offers. To put things into perspective, USDJPY 1Y vols traded at 12.6% at the close of NY last Friday but is now a whopping 14.5% and seems to hold steady even as the Nikkei recovered off the lows (+5.5%) on Wednesday.
Spot remained in a small range today and short dated implied volatilities are coming off slightly but not as hard as one would imagine. 1m is now around 13% still much higher than where it was last week (8.5% !)… and that is after printing a high of 14.25 yesterday. There is little doubt that implied volatilities will come off eventually… the only question is when: holding a short option position waiting for this to happen seems a dangerous proposition, as vols have been paid up not because spot has moved a great deal, but because of the overall uncertainty that reigns in the markets right now.
Risk-reversals are also extremely well bid for JPY calls, as a general risk aversion move and potential JPY repatriation could provide further JPY strength. Here again though, interbank liquidity remains extremely poor and quotes are few and far between.
The below chart displays USDJPY 1 month implied volatility over the last two months.
(Source Bloomberg)
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