By Ron Harui
A Dow Jones Newswires Column
TOKYO (Dow Jones)--How successful were Japan's recent efforts to cap the yen's upside through intervention?
The spot market seems to suggest only partial success. After all, the dollar, at Y117.22 Wednesday afternoon in Tokyo, isn't far off its recent low of Y115.80 set Sept. 20.
But a better indicator might be the options market.
After the Sept. 11 terrorist attacks in the U.S., currency traders scrambled to buy yen call options to hedge against further rises in the Japanese currency. At the time, the dollar was falling fairly rapidly in the cash market and currency players were betting that the trend would hold.
That's when Japanese monetary authorities began jumping into the market. Bank of Japan dollar buying has been frequent though relatively light by historical standards and yet, the dollar's slide came to a stop. In a sign of shifting sentiment, players who purchased yen calls have unwound those positions - presumably at a loss, since an unexercised option loses value as it moves further out of the money and time elapses.
Moreover, players have started buying short-dated dollar call/yen put options.
This activity is important for two reasons. For one thing, it shows that market participants believe the Ministry of Finance and its partner, the BOJ, are committed to supporting the dollar just below current levels.
"We believe the MOF will likely continue to support Y115-Y117 successfully by intervention because intervention is consistent with fundamentals, and the U.S. government appreciates it," said Toru Umemoto, currency strategist at Morgan Stanley.
Further, it could affect the spot rate directly if banks that sell dollar call options delta hedge those positions, a process in which they would have to buy cash market dollars with every dollar rise in order to offset their options exposure.
With the Japanese authorities' apparent success in averting a sharp yen rise against the dollar, some overseas players are now rethinking their short-term dollar bearish scenario. Some of these players have been buying one-week dollar call/yen put options with strikes between Y118.50 and Y119.00, speculating the dollar could rally soon.
Underscoring Japan's resolve to continue intervening to prevent a yen rise, Finance Minister Masajuro Shiokawa said Wednesday: "I told other G7 financial leaders Japan will continue doing its best to maintain the stability of foreign exchange rates." Shiokawa was referring to comments he made in a telephone conference call among the Group of Seven finance ministers late Tuesday.
The rapid slowdown of Japan's economy in past months has sparked concerns among Japanese government officials that the recent yen rise would hurt the nation's waning exports, a major pillar of Japan's economic growth, by making those exports more expensive overseas.
Given worries that Japan's economy is poised to enter a deflationary spiral and that a dollar crisis could still occur, the U.S. government is unlikely to disagree with Japan's currency interventions, Morgan Stanley's Umemoto said.
Reflecting the U.S. government's possible acceptance of Japan's actions, BOJ Governor Masaru Hayami said late Tuesday he doesn't think the U.S. is opposed to Japan's interventions in light of the dollar being sold off in the wake of the terrorist attacks.
Highlighting the decreased downside risk for the dollar against the yen, the one-month quarter delta risk-reversal bias for dollar put options against the yen declined to 1.60%/2.10% in Tokyo Wednesday from 1.9%/2.5% in New York late Tuesday.
Risk-reversals measure the market preference for either put or call options by the premium or discount applied. Delta measures the change in the option value for a change in the underlying foreign exchange rate.
The huge skew in favor of yen call options against the dollar has dropped as market players unwound long yen-call options positions which were built during the last two weeks to hedge against a dollar plunge to below Y115 and bought some yen put options, analysts said.
"A combination of some change in (dollar) sentiment and too much downside risk (in risk-reversals) probably led to buying of yen puts and selling of yen calls," said Ron Leven, currency strategist at Lehman Brothers.
The recent surge in the yen call bias of one-month risk-reversals to above the 2.0% level has made yen put options a very attractive buy because of the cheap cost, analysts said.
"Yesterday, there was some selling of one-month yen calls with Y112.50 strikes and buying of one-month yen puts with Y118.20 strikes, mainly because the level was so attractive," Leven said.
Now that the dollar seems to be bottoming out against the yen, some traders recommend entering into low-cost risk-reversal strategies that would take advantage of a dollar rise in the longer term.
"Assuming a spot rate of Y117.50, one risk-reversal trade is to sell a six-month dollar put with a Y106.50 strike and use the obtained premium to buy a six-month dollar call with a Y125 strike," said a Japanese city bank dealer.
By putting on this trade, market participants would be able to speculate on a dollar rise to Y125 in six months, with a zero cost and an extremely slim likelihood for the yen call option's exercise.