G7 Meeting, Long Gammas and Event Risk in FX Options Market:
Feb 5, 2004
Given the current situation, it seems more plausible that the US officials will try for further flexibility in the exchange rates, which might lead to a further weakening of the USD in the medium term.
The currency options market is expecting something similar on these lines and as a result market makers are scrambling to cover their short gamma positions. The gamma seems to be very well bid as a result and especially those having strikes indicating a weaker USD.
There were some big triggers at 104.50, 104.80 and 105.00 that have expired. These triggers cause the owner to be long gamma, which means every time the spot USD/JPY goes towards 105.00 the owner needs to buy USD/JPY, which can be sold at a higher level. Owning gamma is very crucial before an event risk as the markets can be choppy and long gamma is best to play this. However as those triggers have expired, market makers are caught short gamma below 105.00. Hence the market had seen 104.90 strike being paid at very high prices to cover the short gamma position. It is interesting how the G7 meeting manifest in an event risk in the FX Options market. The market does not want to sell any short dated options, as market makers reckon whatever the outcome of the meeting will be, the currencies should see a good amount of volatility, although the risk is more skewed towards USD getting weaker. Hence USD Puts are very expensive, and perhaps a bit too much. The 1 week volatility traded as high at 14.5 vols, however we had seen the 1 week trade at 17.0 vols just before the last G7 meeting in September last year. The two week risk reversals got paid at 2.00 vols in favor of usd put yen calls, as market reckons another big gapping of usdyen post G7 to sub 105.00 levels. However usdyen had been holding steady at 105.50 with the support of the Bank of Japan. Looking at the situation it seems the market has over-priced the G7 risk, and if we do not see a pre-move in the currencies before the weekend, the volatility might as well come off. However, having said that, if we do see the same after-effect as the previous G7, things might be still too cheap.
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